What is neo-liberalism and why does it matter?

Do free markets actually exist and is the accumulation of wealth the defining characteristic of what it means to be human?


The underlying assumptions governing neo-classical economics and its political expression in neo-liberalism are so flawed that any attempt to re-construct a market economy based on the same assumptions are bound to fail. Markets are a sub-system of society and an institutional mechanism to coordinate economic activity in a political system called capitalism. This varies across time and space depending on country specific institutions (i.e Irish capitalism is different to Finish capitalism). Markets are political constructs and cannot exist without active political re-construction. It is not possible to separate the ‘state’ from the ‘market’. Neo-classical concepts of a ‘free market’, ‘state intervention’ and ‘market failure’ are only possible if we accept the assumption that ‘markets’ are a natural phenomenon that exists free from politics. This is  only possible if we assume certain characteristics about human psychology that are a-historical and anti-social. Thus, the most important critique of neo-liberalism is a moral critique of how it conceptualises human intentionality. Despite claims to the contrary, neoclassical economics is essentially a normative theory.

Capitalism and market based exchange is not possible in the absence of trust, collective association and values of mutual reciprocity.  These are the conditions of social integration that make capitalism possible. The neo-liberal assumption that it is natural for individuals to have pre-determined motivations premised on the ‘selfish’ pursuit of money means that public and private institutions are designed to condition this type of behaviour. In turn, this produces economic cycles of boom and bust rather than assumed ‘market competition’. If a bank is designed to incentivize the maximization of short-term gain for shareholders rather than strategic investment in productive labour  activity why should we be surprised that banks speculate recklessly? Neo-classical assumptions about rationality and market behaviour is internally contradictory and logically flawed. It is not the most efficient way to organise an economy and it is certainly not a way to build the neccessary social and democratic foundations for sustainable living systems. We need to re-design political economic institutions so that they are premised on what it really means to be human. The first way to do this is challenge the libertarian philosophical assumptions guiding contemporary economic discourse.

Where did the politics and economics of neo-liberalism come from?

After the second world war there was a general consensus amongst political and economic elites that the ‘laissez faire’ doctrine of letting markets rip was a complete policy failure. This may have been a  pragmatic decision. It was hardly private capital that was going to re-build Europe after the devastation incurred by the war. The backdrop to the war was a massive economic recession, huge inflation and growing unemployment. These were central conditions that enabled the emergence of a far right political movement in Europe. Another policy lesson that has been lost on contemporary elites. The Marshall plan, aimed at re-building Europe, was the beginning of a coordinating policy discourse that legitimated significant public investment and state involvement in the economy.

The next 30-40 years were premised on a variety of economic theories that set the terms of reference as to what was an appropriate role for the ‘state’ in the economy. Such theories mainly included ‘Keynesianism’ and ‘welfare state economics’. They all agreed that the state had an important role to play in mitigating the worst effects of the private market, particularly insuring citizens against market risk. It was widely accepted that citizens required social protection against unemployment, old age, sickness. Labour markets were to be de-commodified through social security and a variety of social rights were embedded in health, education and pension provision. The introduction of universal suffrage put in place a political mechanism whereby capitalism could be democratized. The state was essentially about managing this tension between capitalism and democracy.

This compromise did not last very long. In fact, viewed from a long-term historical perspective it was a relatively brief period in capitalist development. But, importantly, it was a period that re-considered the role of politics and public institutions in managing capitalism. The state was central to resolving problems associated with ‘wage, work and welfare’. These were considered central to economic development and too important to be left to private market exchange. Political parties, as collective actors in government, utilised administrative power in the interest of a fair wage, full employment and social security. The benefits gained should not be underestimated. It showed that politics when utilised in the interest of the common good can mitigate the worst effects of market economies. Some countries went further than others, particularly the social democratic economies of Nordic Europe. The legacy effects were not without its problems, not least its institutionalisation of a ‘male bread earner’ model of social policy.

From 1970 the debate on the appropriate role for ‘state’ quickly changed. In response to the inflationary impact of the oil crisis, the Keynesian compromise of full employment was quickly shattered. Labour was blamed for excessive wage demands. The state and public expenditure considered wasteful and damaging to the efficiencies of private market activity. It created privileged insiders who were free-riding on the back of private capital accumulation. The terms of the debate on what was the ‘appropriate role for the state and public institutions’ in a capitalist economy was set by neo-liberal theorists such as Milton Friedman, Fredrich Hayek, Geroge Stigler, James Buchanan and Alan Peacock. Hayek published his seminal text on the ‘road to serfdom‘ in the 1940s. It was a damning critique of ‘state interference in the economy’. It was a relatively unknown piece until Friedman popularised its ideas in ‘capitalism and freedom‘. This ideas became a reality with the election of Margaret Thatcher in the UK and Ronald Reagan in the US. Politics enabled an economic theory become a global practice.

This unholy alliance between a neo-classical economics (centred on controlling the money supply through interest rates and independent central banks) with a philosophical-moral text in Austrian-Hungarian libertarian theory should not be under-estimated. The welfare state was now considered less the ‘Socialstaat‘ of German social democracy but an institution of self-seeking politicians and civil servants who act in interest of rent seeking interest groups. Any form of collective organisation such as trade unionism, regulation and public governance was considered antithetical to the freedom, creativity and efficiency of private markets. The state was corrupt, expensive and a drag on the creativity of autonomous markets.

In fairness, there was good reason to be critical of the state. It had become an administrative jungle and there is no doubt that bureaucratic inefficiencies were rampant. The legacy of totalitarianism and state dictatorships was lingering in many aspects of public administration. But, the critique was focused less on these problems than the ‘role of the state’ and ‘politics’ in a system that was democratic. Given that neo-classical economics works on the assumption that all individuals are self seeking, it was assumed that all public policies are designed by self seeking interest groups. This favours ‘particular’ interests over the ‘general’ interest of markets. Thus, neo-liberalism became popular less for its economic arguments but its moral arguments about the superiority of markets, the individual over the collective, private over public.

This new school of economic thought set the rules as to what was the appropriate boundary between the ‘private market’ and the ‘state’. It was by defining this boundary that neo-liberals set the political agenda for the last two decades. Everything had to be justified on the basis of an acceptable ‘market intervention’. The state could only ‘intervene’ if there was market failure. Thus, it could maintain law and order, private contracts or competition laws because these were seen to correct market failure. The state could enable and facilitate the functioning of perfectly efficient market economies. Welfare economics was quickly subsumed under this logic. It a mechanism to coordinate in the interest of markets.

The myth of making markets free from state intervention!

It was not that long ago when attempts to remove slavery were considered a unnecessary intervention in a free labour market.  Today, many make strong arguments as to why international legislation criminalising child labour is an unnecessary regulation that would lead to an exit of capital from ‘developing economies’.  Similarly, it is standard to hear economists and employers arguing against environmental regulation (control of emissions, pollution standards, health and safety) as an intrusion upon the freedom of business.Or, think about Brian Cowens argument, supported by most of the media, economic consultants, builders, developers and banks when he publicly stated that ‘it is not the role of the state to interfere in the housing market’.

Labour regulations on working hours, sick leave, parental leave, contracts of employment, dismissal, minimum wages are all considered unnecessary interventions in the labour market by organised business groups. IBEC roll out their ‘experts’ to show that any attempt at regulating the labour market in the interest of workers will lead to job losses.

Trying to define a ‘free’ market is a futile exercise. What constitutes a ‘free’ market is ultimately a political decision. A failure in one market might be considered a success in another. If the primary purpose of market activity is to increase GDP by at least 4 percent every year then anything that achieves this (regardless of whether it is a housing boom, export expansion or the consumption of milky bars) is a good thing. Pollution is good if it increases GDP. Growth and capital accumulation is all that matters. In reality, most economies want a particular type of growth and it is generally based on making stuff and selling it in ‘free international markets’. But, what if the objective was to minimise income inequality? Some might consider (as I do) high levels of income inequality as a ‘failure of the market’. Should the state step in and re-distribute? According to neo-liberalism it should not. The neo-classical market is not supposed to create an equitable distribution of income or resources. Thus, given that the ideal model says it is OK, well then it is OK!

Furthermore, given that the ‘ideal free market’ without ‘failure’ or ‘state intervention’ is premised on competition you would probably expect neo-liberals to break up monopolies. They do. They despise monopolies, particularly those in the public sector. Therefore, competition policy (as the primary legislation of the single European market) is designed to correct market failure by breaking up large semi-state companies in telecommunications, transport, energy etc. Does this mean that the state is allowed to break up the monopoly of Tesco? Absolutely not, this would not be a correction of market failure, it would be state intervention in a private market.

For the neo-classical economists market failure equates to economic failure. What might make really good economic sense (i.e. a public investment bank, economic planning to ensure the productive use of capital, investment in job creation) to those with common sense is a failure and inefficient state intervention by neo-classical economists. Public policy is and has been determined by all of these assumptions for the last 20 years. It fails to recognise that markets are a politically constructed institution with significant normative implications for society. A perfectly competitive market that is ‘free’ has more in common with Plato’s cave or Catholic purgatory. It is an idea!

In the beginning there were ‘markets’ – then came the humans!

In neo-classical and neo-liberal economics markets are assumed to be the primacy constitutive force upon which everything else was built. It is therefore unsurprising that they view all forms of collective organisation, particularly the state, as an intrusion. I mean, they were here first! The state is considered a contractual relationship amongst fully informed rational-utility maximisers that cordially sought to put in place a system of rules, laws and social order to ensure the freedom of markets. There is not a single economic historian who could say this without laughing. Capitalism is premised on accumulation and in the beginning there was war, rape, pillage, hoarding and land grapping that gave ultimately rise to the structured geographical space of the world was we now know it.

When markets were designed they occurred not through the free association of men at the edge of a forest selling fruit and nuts. The concentration of power in the political elite determined, structured and conditioned the rules of private market exchange. It is true, the liberal movement reacted against this and civil society agitated for the freedom to own, sell and buy property. But, this was long after the enclosure movements. The market was not natural and it did not emerge spontaneously, it has always been dominated by those with the most capital. Historically, this happened to be political elites in what later became the state. Furthermore,  in terms of the ‘price mechanism’ ( the central tool for competitive markets to function) it is rare if ever that prices are not influenced by political decisions. Interest rates and wage labour affect the price of everything and these are rarely if ever set by markets. Central banks are indpendent in theory but rarely in practice. The current wave of ‘quantitative easing’ or ‘printing money’ in the US Fed is a contemporary example. This is the result of political pressure to tackle unemployment (and risking inflation).

For neo-liberals all economic problems can be resolved by depoliticising them. Economics then becomes a simply task of technocratic determination rather than political or democratic deliberation. The attempt to de-politicise the market (think finance, banking, regulation, central banks etc) is an attempt to refine the boundaries as to what is politically contestable. Given their assumptions of the free market they are in a position to dictate what constitutes a legitimate boundary between the ‘market’ and ‘state’. This is being played out across Europe at the moment. People are told that the austerity measures (informed by neo-liberal orthodoxy) are the ‘only game in town’. Politicians themselves buy-into the assumption that they are incapable of proposing democratic alternatives to the bailout of European banks with public money.

But, in contemporary terms, markets were only made possible through the establishment of property rights and the provision of physical, technological, industrial and communicative infrastructure. The internet was made possible through US state funding of research and development. This was a point made by Michael Martin (new leader of Irish political party – Fianna Fáil) the other night on ‘public TV’. He made the argument (and, despite my differences with the minister he was correct) that during the boom years Irish capitalists were focused on making a quick fix in the property market (facilitated by domestic tax policies enacted by his government) and it was the state who set up capital venture funding for indigenous enterprise.

That the state is so central to industrial policy, economic planning and the trajectory of growth in an economy it defies belief that we still use neo-classical assumptions of ‘free markets’ in analysing and proposing public policy. No country in the world has achieved industrial development by the ‘free market’. It necessitates developmental efforts and substantial ‘state intervention’.Until this assumption of the state is abandoned there will be no improvement in that aspect of society called ‘the economy’.

Who is this homo economicus in the theory of markets?

Central to the politics of neo-liberalism is an assumption that people are greedy, selfish, self-seeking and pretty much horrid social creatures. The only reason why someone would get involved in politics is to satisfy their thirst for power. They will allow sectional interests rule policy formation, particularly trade unions and organised labour.  All neo-classical economics is premised on ‘homo economicus‘. Humans are rationally and narrowly self-interested and have full capacity to make calculated decisions as to what is in their interest. In game theory this means that actors will rarely if ever co-operate. Co-operation is unnatural. In reality, human societies have evolved and become successful by virtue of our capacity to co-operate. If we really were homo economicus we would probably be still fighting with the chimps.

In fairness, the assumption of a rational calculator by economists is probably not meant to be an anthropological description of human action but an analytic tool to build fancy mathematical models. But, do we really want an economy that is designed for humans as rational calculators but emotional orangutans? Even though it is an analytic device it is has led to the economisation of what constitutes human action. It has evolved into a substantive anthropology that assumes the unfettered pursuit of materialistic wealth, the accumulation of more and more money, is the defining characteristic of what it means to be human.

This is despite the fact that there are thousands of published papers, in a whole variety of scientifically established journals,  that argue in favour of a much more nuanced concept of rationality. Most people have a deep intuitive sense of right and wrong when it comes to the distribution of resources that completely contradicts the notion of rational egotism. But, more importantly, most research on human action has shown that it is not timeless and ahistorical. It is deeply affected the sociocultural and historical context within which it is situated.  Reductionist explanations of human action (which includes the more esteemed neurosciences as well) are premised on a methodological individualism that enable, facilitate and ultimately prescribe a particular type of behaviour.

Rational choice is always embedded in moral choice. Even Adam Smith recognised this. Whilst it is rarely mentioned in economic textbooks but ‘the wealth of nations‘ was premised on book he completed earlier in his career called ‘the moral sentiments of markets‘. This book, whilst it is not exactly convincing, accepted that markets are political constructs and require a foundation of trust, communication and social solidarity that markets ultimately cannot provide. Neoclassical economics and the politics of neo-liberalism is a failed strategy because it is premised on a  conception of markets, state, and individual human action that is simply not true. It is not a science but a normative theory. The only way to challenge it is to develop an alternative framework based less on science but moral reasoning, collective action and political mobilisation.

4 responses to “What is neo-liberalism and why does it matter?

  1. Pingback: #OccupyDameStreet and the Curious Case of Politics in the Street « alanrouge

  2. Reblogged this on Sapient State and commented:
    This is a great essay describing the basis for and factors leading to neoclassical economic and neoliberal political ideologies.

  3. Reblogged this on I Dare. I Speak. and commented:
    The Economics of Greed.

  4. Nice Post. This is seriously awesome and doubt clearing. Neo-Classical Economy is built and running on the unacknowledged work of Labors.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s