The ‘Golden era of Capitalism’ that economic historians talk about was the quarter century after World War II, in 1950s-1970s, when economic growth in developed and developing countries were at peak and more equitable (less inequality).
This era’s dominant (mainstream) economic thinking was that of John Maynard Keynes, a British liberal economist who had shown the path out of the 1929 Great Depression. His methods were used again to overcome the Great Recession of 2007-08.
Keynes prescribed a bigger role for the state in running the economy by way of higher fiscal spending to generate demand (demand side solution) since money supply (liquidity) by lowering interest rate had failed to induce higher investment and growth to neutralise the 1929 recession that ended with depression.
The neoliberal economics that replaced it sought a bigger role for market to run the economy in which state’s role is limited to managing money flow through interest rates (supply side solution) and let market bring in growth and ensure better living standard for people.
Tumultuous decades of 1970s
This change happened because of several developments that took place towards the end of 1960s and continued through 1970s and 1980s in many advanced economies like the US and UK.
As former RBI governor and professor of finance at the University of Chicago Raghuram Rajan writes in his 2020 book ‘The Third Pillar: How market and the state leave the community behind’, “growth slowed down in 1970s, inflation picked up and resource strapped governments had to look for new ways of energising growth”.
By that time, Rajan writes, “inefficiencies stemming from state intervention and private-sector cartelisation were masked by the continuing productivity benefits as the Second Industrial Revolution spread to the corners of every country”.
He draws attention to a series of events that took place then: oil prices tripled (in retaliation to western countries’ support to Israel in war against Egypt), the Vietnam war spending caused higher inflation in the US, interest rates went up, the Bretton Woods system of fixed exchange rates broke down as the US abandoned convertibility of the dollar into gold etc.
Nobel laureate Joseph Stiglitz wrote in his 2009 book ‘Free Fall: Free markets and the sinking of the global economy’ about the US situation: “By 1970s there was a new problem, inflation, and a new generation of economists. The problem of 1930s was deflation, the fall in prices. To the young economists who were making their mark, that was ancient history… The fact that most of the post-war recessions were associated with the Fed tightening credit excessively confirmed conservatives’ prejudices that it was government failures, not market failures, that were responsible for any aberration from perfection.”
The UK faced a similarly tough situation. Prof. Dennis Kavanagh (politics) at the Liverpool University wrote that this period was marked by slow growth, high inflation, high unemployment, worsening trade balance and additionally, strong trade unions demanding higher wages with frequent labour strikes.
The UK approached the International Monetary Fund (IMF) for ‘rescue’ in 1976 and was granted a loan “in return for spending cuts and continued anti-inflation policies”, signalling the end of the Keynesian era.
Pro-market policies were first adopted in the UK by the Margaret Thatcher government in late 1970s and 1980s when the balance tilted completely in favour of market, and against the government. Later, in 1980s the same policies were adopted by US President Ronald Reagan.
Washington Consensus and neoliberalism in developing economies
The Washington Consensus, a set of economic policies that pushed market over state in developing economies going through a debt crisis, became the order of the day in 1980s. “The term Washington Consensus”, Enclyopaedia Britannica explains, “usually refers to the level of agreement between the International Monetary Fund (IMF), World Bank, and US Department of the Treasury on those set of policy recommendations. All shared the view, typically labelled neoliberal, that the operation of the free market and the reduction of state involvement were crucial to development in the global South.”
In 1991, India adopted those policies when the IMF put similar conditions on India when it sought its bailout due to a foreign exchange crisis.
There was another development of great consequence in 1970s and 1980s: weakening of the communist Soviet Union to its eventual breakdown and China’s turn from communism to capitalism (combing state planning in its economic reforms that promoted state-controlled private sector), reducing choices for many developing countries to turn to them for bailouts and spreading the Washington Consensus across the world.
Essentially, it was an ideological war between the primacy of state and that of the market in which the balance of power shifted from the former to latter. The state retreated and the market advanced. It was a march in reverse of the post-war period; while earlier it was the state which took control of production and services (nationalisation), imposed tighter controls on market, especially on financial flows, the neoliberal era saw state handing over production and services to private sector (privatisation).
As this shift happened, the market was gradually deregulated towards the neoliberal idea of a self-regulated market (SRM).
This was something that even Adam Smith, whose classic free-market concept neoliberals claimed to be championing, had not proposed. He was for a “competitive” market system “embedded in an appropriate legal and institutional framework – an insight that Smith developed at length but that was largely overlooked by later generations”.
Commenting on the shift (while referring to many communist countries adopting capitalism), Stiglitz wrote (2009) that they turned to a “distorted version of a market economy” that neoliberal Nobel Laureate Milton Friedman championed.
Friedman’s ideas, especially his monetarism, had a big contribution to this shift, particularly his formulation that limits the role of government merely to regulate money supply (to determine production, employment and price) and the futility of government interventions to increase employment.
State shrinks, market dominates
Talking about Friedman’s dramatic rise, Nobel laureate Paul Krugman wrote (2009): “…Friedman made a compelling case against any deliberate effort by government to push unemployment below its “natural” level (currently thought to be about 4.8 per cent in the United States): excessively expansionary policies, he predicted, would lead to a combination of inflation and high unemployment – a prediction that was borne out by the stagflation of the 1970s, which greatly advanced the credibility of the anti-Keynesian movement.”
Growth picked up by this change to pro-market economics but not to the level achieved during the Golden Age of Capitalism. When the 2007-08 Great Recession hit, failure of a deregulated market running the economy in developed countries became painfully obvious and attracted censure in public debates.
By now we knew the fruit of growth under pro-market policies have benefited only the top 1%, impoverishing the rest 99%, courtesy French economist Thomas Piketty.
His work on India (with fellow economist Lucas Chancel in 2017) showed how inequality had grown rapidly after the 1991 liberalisation which adopted many of the neoliberal concepts. They showed that during 1951-1980, the bottom 50% held 28% of total growth and their incomes grew faster than the average. During that period, incomes of the top 0.1% decreased. But that trend reversed during 1980-2015.
Stigliz explained that “the poor suffered under market fundamentalism (neoliberalism or deregulated market). Trickle-down economics didn’t work”.
Nevertheless, he also issued a warning: “But the poor may suffer again if new regimes again get the balance wrong, with excessive intervention (by state) in the market. Such a strategy will not deliver growth, and without growth there can’t be sustainable poverty reduction. There has been no successful economy that has not relied heavily on markets.”
What he makes clear is that there has to be a good balance between state and market for both higher growth and to benefit a majority of people. Leaving market to run an economy is a bad idea.
Pushing bizarre policies with no basis in economics or evidence
Neoliberalism has spawned many concepts which have no economic basis or historical evidence to support.
For instance, the trickle-down theory which posits that growth at the top will trickle down to the bottom. Real life experience has shown this to be misleading. The IMF’s own studies and that of leading economists have shown that it is completely baseless. The IMF studies showed benefits don’t trickle down and hence the need to raise income levels of the people at the bottom.
This concept has been used for spawning another bizarre idea that cutting taxes for the rich will benefit the non-rich. The argument being lower tax will propel higher investment, generating higher growth and employment that will benefit the non-rich.
The US experience of massive corporate tax cuts from the time of Ronald Reagan to Donald Trump shows that none of the sort happened. Instead, tax cuts shrink the resources of state and its capacity to invest in an economy, particularly for generating public or social goods.
In fact, there is a good case for taxing the wealthy (higher ability to pay) to general resources. There is ample evidence that lowering of corporate tax has accompanied increased tax evasion and avoidance through shell companies and tax havens.
In addition, tax incentives benefit corporates more than individuals and bigger corporates more than the smaller ones. For example, in India, the effective tax rate for companies with more than Rs 500 crore of profit before tax (PBT) has been consistently lower than those with Rs 10-50 crore of PBT.
The ill-effect of India’s decision to cut corporate tax by Rs 1.45 lakh crore in September 2019 is reflected in its economic package of Rs 21 lakh crore to kick-start the locked down economy.
The fiscal spending component is 7-9% of it or about 0.75-1% of the GDP, while leading economists have been asking for about 5% of the GDP.
The Indian government’s economic package also carries the print of another failed neoliberal economic concept that money supply will address demand side constraint and hence, a massive dose of liquidity infusion component in it.
In other words, fiscal austerity (another neoliberal construct) is needed since state intervention is futile to address unemployment (or distress in economy) as Milton had proposed.
But experience shows, it didn’t work in the 1929 Great Depression or in the 2007-08 Great Recession and the Keynesian prescription of fiscal spending to get out of the crisis was applied on both occasions.
Experience has repeatedly shown that during a recessionary phase, lowering interest rates does not boost private investment as people and businesses choose to hold cash, given the uncertainties.
In India, most of the excess liquidity generated through lowering of interest rates has ended up bloating the RBI’s own reverse repo account because banks are unwilling or unable to lend.
There are many more bizarre neoliberal constructs. One posits that higher wages will lead to lower employment. The argument is that higher wages will lead to higher cost of production and services, lowering demand for them and hence to lowering of economic activities and job cuts.
But in practice, India has seen this leading to abysmally low wages, more casual than regular workers in its workforce, denial of social security to most and denial of benefits of growth in productivity to workers.
Another such concept is ‘voluntary unemployment’. This concept suggests that high unemployment is because workers are choosing not to work, that they have financial incentives not to work.
Why would anyone look for a job, which is the criterion for classifying or declaring anyone as unemployed if unemployment is a voluntary action? The illogic of it never mattered to neoliberals.
The Chicago school’s Casey Mulligan is credited with this concept of voluntary unemployment; his colleague John Cochrane went a step ahead to add that unemployment is good, recession is good, adding for good measure: “People who spend their lives pounding nails in Nevada need something else to do”.
This concept was brought into India in 2017 when Bibek Debroy, who heads the Economic Advisory Council to the Prime Minister, tried to explain away massive job losses being reported. 2017-18 later turned out to be the year when unemployment reached a 45-year high.
Some economists call such neoliberal economic concept as “snake-oil economics” – deceptive or misleading. They have decidedly harmed welfare of the majority of people world over.
Here is food for thought.
With half of India’s population poor, according to the World Bank data of 2019; the apex government think tank Niti Aayog’s 2019 December report showing hunger, poverty and inequality growing in 22 to 25 states/union territories of 28 it mapped; high and growing inequality (India ranks 95 among 159 countries with a Gini coefficient score of 35.7 ) and an official admission that 60 million people are being pushed into poverty because of “catastrophic expenditure” on healthcare, there is little reason or logic for India to adopt and apply the bizarre neoliberal economics.
(NB: ‘state’ and ‘government’ have been used interchangeably; ‘market’ stands for private economic structures facilitating production and exchange in the economy.)