NEO-LIBERAL FREE-MARKET ECONOMICS RULES - BUT DOES IT WORK?

The dominance of free-market thinking.

At the core of the doctrines of those shaping economic policy in the United States and Britain is a deep belief in the freedom of individuals to pursue their interests with the least interference from government or obligation to 'society'. So deeply has this body of dogma permeated contemporary thinking, that some policy-makers may be only dimly aware of what is driving them.
One of the high priests of neo-liberal free market capitalism is influential member of the Austrian school of economics, Ludvig Von Mises. The Mises Institute is now based in Auburn, Alabama, not Vienna, and is extremely active in spreading the free-market word world-wide. Its basic philosophy is quite clear:

Mises concluded that the only viable economic policy for the human race was a policy of unrestricted laissez-faire, of free markets and the unhampered exercise of the right of private property, with government strictly limited to the defense of person and property within its territorial area. (Prof. Murray Rothbard, disciple)

The neo-liberal word is now spread by a vast network of 'research' institutes and education and proselytising foundations, which all have the same root beliefs and purposes, but usually clothe their basic individualistic dogmas in slightly more elaborate 'freedom' apparel. The US Heritage Foundation is a classic example:

The Heritage Foundation is committed to building an America where freedom, opportunity, prosperity and civil society flourish.

How to recognize free-market dogma

Just look for the following axioms and key phrases:

• Low taxes lead to greater freedom and higher economic growth
• Individual Choice must be a primary aim of public service provision
• Government involvement promotes bureaucracy, inefficiency and corruption
• Anything produced or done by the IMF or World Bank is for the benefit of all countries
• Creating untrammeled individual freedom is the primary political aim
• Individuals should be encouraged to amass as much wealth as possible - this encourages enterprise and the fruits of successful enterprise will benefit all by trickling down to the less fortunate
• Privatisation creates efficiency, competition and consumer choice - even of basic commodities like electricity and water
• Private/ public partnerships are the best way to manage public service capital projects
• 'Modernisation' must be a primary aim of government
• Leaving such key elements of national infrastructure like communication and transport to the wisdom of the market will produce the best results
• Government should stay out of anything to do with finance or industry
• Very light regulation of banking and finance encourages competition and entrepreneurship

And.....

Beware any American institution that promotes 'freedom' as part of its mission.

Now, just so readers are clear, the writer is a committed capitalist and political/ economic historian by education. And because I was taught at university to value independent thought and denigrate dogmas that fly in the face of good evidence, I would make the point that laissez-faire free-market capitalism is only one version of the 'truth'. Everybody will have heard of John Maynard Keynes - but less may have heard of social market capitalism, versions of which have been very successfully practiced in the Scandinavian countries, the Netherlands and America's neighbour, Canada.

It should also be noted that the Asian versions of capitalism as practiced in countries such as Japan work in cultures that have little to do with those of the US and UK.

So, it appears as though there may be many routes to social and economic progress. But scanning much of the Anglo-American press, listening to UK politicians in New Labour and the Conservative Party, reading journals such as 'The Economist'', and hearing the words of the many free-market think tanks leads only to a range of assertions about the purity and goodness of the market.

Such thinking has now reached the level of unchallengeable axioms and it must be very difficult for many people to disbelieve the efficacy of the axioms above, despite the fact that all of them are open to challenge and contradiction by the evidence.

So, what is the evidence?

Let's start with an interesting article by American historian Robert Brenner in the Guardian:

The bull runs of the 1980's and 1990's and the first half of this decade, with their epoch-making transfer of wealth to the richest 1% of the population, have distracted attention from the actual long-term weakening of advanced capitalist economies. Economic performance in the US, the bulk of Europe and Japan has, by virtually every standard indicator - output, investment, employment and wages - deteriorated, decade by decade, business cycle by business cycle, since the early 1970's.

The early years since the current cycle began in early 2001 have been the worst of all - in the US, growth of GDP and jobs has been the slowest since the end of the 1940's, and real hourly wages for about 80% of the workforce have languished at about their 1979 level.

The decrease in the dynamism of the advanced capitalist economies is rooted in a major drop in profitability , caused by a chronic tendency towards overcapacity in global manufacturing , going back to the !960's. Reduced profitability has, since the 1970's, led to a steady decline in the rate of investment as a proportion of GDP, as well as step-by-step reductions in the growth of the capital stock and of employment. This slowdown of capital accumulation, along with a push by corporations to restore their rates of return by holding down wages, has reduced aggregate demand - a weakness that has long constituted the main barrier to growth in the advanced economies.

Governments, led by the US, have underwritten ever greater volumes of debt, through ever more baroque channels, to subsidise purchasing power. In the 1970's and 1980's they incurred continuously larger deficits to sustain growth.

But since the mid-90's, they have had to resort to more powerful and more risky forms of stimulus to counter the tendency to stagnation, replacing the public deficits of traditional Keynesianism with the private debts and asset inflation of what might be called asset-price Keynesianism - or , with equal accuracy, Bubblenomics.

Despite his recent protestations to the contrary, none other than Alan Greenspan launched the experiment in the new macroeconomics, nurturing the great stock market run of the late 1990's, after the attempts by the Clinton administration and the EU to wean the economy from its dependence on credit, via neoliberal budget balancing, were met by deep recessions in Europe and Japan, the jobless recovery in the US, and the Mexican peso crisis. As corporations and wealthy households enjoyed their growing paper wealth, they embarked on a record-breaking increase in borrowing, sustaining a powerful expansion of investment and consumption, the ill-fated "New Economy" boom. However, the ascent of equity prices in defiance of falling profit rates and the escalation of overcapacity that resulted from accelerating investment prompted the crash and recession of 2000-01.

Undeterred, central banks turned again to the inflation of asset prices. By reducing real short-term interest rates to zero for three years, they facilitated an explosion of household borrowing that contributed to, and fed on, rocketing house prices. Inflated household wealth enabled increased consumer spending that, in turn, drove the expansion.

Personal consumption, plus residential investment accounted for 90 - 100% of the growth of GDP in the first five years of the current cycle. However, the housing sector alone was responsible for raising the growth of GDP by more than 40%, obscuring just how weak the recovery was.

The rise in demand revived the economy. But, while consumers did their part, the same cannot be said for business, despite the incitement of unprecedented household borrowing. Focused on restoring profit rates, corporations unleashed an unprecedented offensive against workers. They increased productivity growth, not so much by investing in equipment as by cutting back on jobs and forcing employees to take the slack.They held down wages as they squeezed more output per person, allowing them to appropriate an entirely unprecedented share of the increase that took place in net non-financial GDP.

Non-financial corporations have, then, raised their profit rates significantly , though still not back to the already reduced levels of the 1990's.

But by holding back job creation, investment and wages, they have held down the growth of aggregate demand, undermining their own incentives to expand.

Instead, exploiting the cheapness of credit, they have devoted a record share of their resources to buying back their own shares, financing mergers and acquisitions, and paying dividends to stockholders - rather than expanding investment and creating new jobs.

What are Brenner's key assertions?

1. The last 20 years or so, that is the period over which free-market economics has dominated, has seen a quantum rise in inequality - between rich and poor nations and between individuals within some countries
2. Neo-liberal, free-market economics has not created better economic performance in those countries practicing it.
3. Corporate performance has been dire, but companies have worked to keep profitability and dividends high by exploiting employees and limiting investment
4. Poor underlying performance has been masked by 'bubblenomics' - creating cheap credit, encouraging burgeoning debt and borrowing against inflated asset prices in such as housing. Large parts of the population are exposed to the risk of ruin if they cannot repay their debt, a situation that could easily arise if, for example, house prices dipped significantly.
5. Corporations have not contributed to growth because they have not increased the asset stock by investing
6. Governments, following free-market principles, have delegated investment, borrowing and debt management to global banks, which are hardly regulated at all. This has created an orgy of unsecured lending, plus greatly increased instability in the world economy, as the amount of risk buried in the banking system is completely unknown.

Make up your own mind - some Facts

Inequality

In the US, wealth inequality decreased from about 1929 to the early 1970's. From 1970 to 2000, inequality has doubled. Now the most wealthy 1% possess 40% of total wealth.

In 2000, the top 20% of wealth owners possed 84% of total wealth, leaving16% to the remaining 80%.

In the UK, the proportion of the population earning less than 60% of the national median was 14% in 1979, 25% in 1996/7, and 22% and rising again in 2005/6.

The UK and particularly the US have greater levels of relative poverty and inequality than most industrialised countries. The US is world leader amongst developed nations.

US productivity per head rose by 16% between 2000 and 2005. Nominal wages rose by 7%. US per capita income rose by 2.3% between 1960 and '79, 1.5% between '79 and '89, and less than 1% between '89 and '96.

Real household incomes fell in 94% of the states (47 out of 50) in 1999-2005 - an average drop of 6%.

During the last 27 years (1977-2004), US inflation-adjusted median income fell 7.5% for full-time male workers, forcing more mothers to the work-place to try and make up some of the family income loss.

So, if inflation-adjusted incomes did not increase for the median family, then obviously some families did better than others. Some up, some down.

The left chart shows the percentage change in inflation-adjusted incomes of families with children for the lowest 5^th of families to those in the top 5^th of family incomes - - from the late 1970s to 1996/97.

Looking at the chart, it can be seen that for the lowest 5^th of families real incomes fell 21% during past 2 decades, while incomes for the highest 5^th increased 30%. That's a big difference.

Economic performance

Growth rates - GDP.

growth in output %

Growth in GDP per head, US and UK

Corporate performance UK/US

Click FTSE 100

R&D expenditure

Brenner is correct. Only Japan has seen significant increases in R&D spend in the period 1985 to 2002.

• US Business R&D expenditure has decreased from over 2% of GDP in 1985 to about 1.7% in 2002. Government spending has reduced even further.
• UK business spend has decreased from about 1.5% to 1.2% over the same period. This, compounded by significant reductions in government spending over this period, means that UK expenditure is the lowest of all industrialised nations

Savings and debt

US Household Savings Plunge

Americans have not saved so little since the depression of the 1930s. They have been on a spending binge, well beyond growth of their incomes. (Bloomberg Jan 2006)

If families have less inflation-adjusted income, despite more mothers working, then family personal savings must suffer as a consequence - unless, of course, families reduce their consumption. But, families increased consumption spending and, to cover this, they reduced savings to historic lows and increased household debt to historic highs.
Dangerous Trend !!!

The chart shows a 48 year trend of that part of disposable income that has been saved - - called 'personal savings rate'.

Note: prior to 1970 the rate of personal savings was rising smartly - - as were family incomes per the first chart above - despite most families then having but one wage earner while also living without increasing debt ratios (chart below).

Then, family incomes stagnated - - and the saving ratio stopped rising as seen in the left chart - - then started falling rapidly - - plummeting since 1992. As of Summer 2007, savings were negative 1.3 percent - an all-time record low!!

Also a record low for any leading global economic power in the modern history of the world, per economist Steven Roach Nov. 2006.

In 2005 consumers drew down savings by over $200 billion compared to the prior year, the biggest dip in savings since record-keeping began in 1929 (Bloomberg). $1.1 Trillion in savings missing in 2005 compared to had savings ratio been as 2 decades ago. (Realized capital gains/losses, if any, are not included, and may slightly mitigate this chart if one wishes to call such savings. Nevertheless, the trend with and without is at an all-time record low).

US Household Debt Soars

Total Debt burgeons

the economy is 2-3 times more debt-dependent - -
with $29 Trillion DEBT EXCESS compared to prior debt ratios

This is A SCARY CHART - showing 4 decade trends of America's total debt (the red line, reaching $48 trillion) vs. growth of the economy a measured by net national income (blue line), adjusted for inflation in today's dollars.

America's Total Debt is here defined as all U.S. debt (sum debt of federal and state & local governments, international, and private debt, incl. household, business and financial sector, including federal debt to trust funds).

Note from 1957 to the early 1970s each curve approximately doubled - meaning about the same ratio of debt was supporting national income growth, despite paying on old WW II debt and covering Korean and Vietnam wars.

Had the economy become less debt dependent after that we would have expected debt to slow down. But, instead, it took off.

In just the 1990s real debt increased more than two times faster than growth of the total economy - - despite zero cold wars.

Other charts show the driving culprits were not only federal government debt ratios (which stopped falling in early 1970s and reversed strongly to the upside - growing 2x the economy) - but, not to be left out, other main culprits were accelerating household debt (growing nearly twice the rate of the economy, and domestic financial sector debt growth (at rates 4 times faster than general economic growth).

This chart clearly shows the accelerating reliance on debt to drive economic growth in the past 2 decades, compared to prior periods.

Assessment.

Well, it looks in aggregate as though Brenner is right, although he may exaggerate some of the downsides a little :

It is strongly evident that neo-liberal free-market economics as practiced in its host countries, the UK and US, has:

• Not created stronger rates of growth than in previous eras
• Greatly increased the rates of relative poverty and inequality in both countries
• Vastly increased the reliance of both economies on high levels of national, household and personal debt
• Reduced industrial performance and investment
• Created an unstable economic outlook, with scary volumes of unknown risk slushing around in unregulated global financial markets, and increasingly frequent crises

So why do we put up with economic dogma that has not produced superior results, has created massive wealth for a very few and relative impoverishment for the majority??

Alternatives?

There are other forms of capitalism right under our noses in some Scandinavian and Northern countries, including to some degree US near neighbour Canada.

The essential differences between them and neo- liberal economies are that they are supported by cultures that value equality, high trust at personal and societal levels and are not averse to high levels of governmental participation in economic and social affairs.

Social market, or Nordic approaches are intelligently flexible

They are also not hung up on economic dogma or zealotry and can be quite pragmatic in flexibly responding to problems or new challenges - in other words, they use intelligence rather than dogma to adapt to changing circumstances.

Neo-liberals, if they are to stay faithful to their dogmas have markedly less weapons at their disposal - essentially, let the market solve the problems. This hardly seems an intelligent way to address complex issues.

Eindhorn and Logue* characterise the so-called 'Nordic' model as that in which:

• An active and interventionist state,
• Provides universal transfer payments to support the elderly, disabled, unemployed and families with numerous children and low market incomes,
• Provides universal social services for health, education, childcare, services for the elderly and the like,
• Uses national policy to achieve high rates of labour force participation and full employment on the national level, via both macro-economic and sectoral policies,
• Integrates major interest groups in making and implementing national policies (rather than the capture of the state structure by a single group of interests, or state capture of the interest organisations),
• Possesses a strong civil society with encompassing and democratic organisation of interests, but particularly the strong organisation of those otherwise weakest in capitalist society - family farmers and urban workers,

We would add one other characteristic that other researchers have highlighted - great openness to the external world that enables Scandinavian companies to compete and adapt in the global economy, in collaboration with supportive unions and governments which (unlike the US) provide extensive social welfare and support for labour market flexibility, together with high levels of skills training and retraining.

By contrast, despite the free-market rhetoric, the US is one of the most protectionist countries in the world.

* Economic and social security in Scandinavia. Eindhorn and Logue, University of Massachusetts.

Contrary to the rumouring of neo-liberals, the roles of government and of the national representative organisations for owners, managers, labour and industries are extremely positive. Also contrary to popular belief, the support and security experienced by employees actually increases the flexibility of the labour market, skills and levels of enterprise.

Wealthy elites or healthy societies?

Very simply, the social market market models, intelligently managed, not only create successful economies but also healthy societies for all their citizens - unlike the UK and US, which spawn great extremes of wealth, contrasting with equal extremes of poverty and inequality, whilst not improving overall economic performance.