Principles of Neoliberalism

Version 1.23
Brad DeLong
ca. March 1999

Originally Published here: Principles of Neoliberalism. Reformatted by Larry Hamelin

Neoliberalism is many things. It is:

  • A counsel of despair with respect to the possibility of social democracy today (outside of the global economy's industrial core).
  • a counsel of hope with respect to the prospects for rapid market-generated economic development outside the global economy's industrial core — if governments adopt market-conforming policies.
  • a bet that improvements in transportation and communication — the shrinking world — "globalization" — gives us today an extraordinary opportunity to rapidly reduce global inequality by incorporating more and more people and more and more more regions into the global economy.
  • the only live utopian program in the world today.

A counsel of despair...

After World War II in Latin America, and at the achievement of independence elsewhere outside the global economy's core, there were high hopes that social democracy (or something further to the left) could be successfully instituted. And there were high hopes that such social democratic or socialist regimes would enable peoples living outside the core to cut a generation or more off of what had been a lengthy, bloody, and cruel three- or four-generation process of industrialization and democratization in northwest Europe and its settler colonies.

Social democratic or socialist governments would from the beginning establish strong redistributive social insurance states to severely reduce the income and wealth inequalities that had been characteristic of Bismarckian Germany or the Gilded Age United States. They would put into place the physical infrastructure to reduce infant mortality and disease that the aristocracies and bourgeoisies of northwest Europe had not thought profitable. They would spend money like water on education.

Moreover, they would use Keynesian policies to make sure that growth was free of the recessions and depressions that characterized industrialization in the industrial core. They would carefully manage their connections with the global economy — choosing the level of the real exchange rate, controlling imports so that imported goods were those of high social utility, preventing artificial drives for export success from raising the prices of necessities to the people, and establishing national independence from imperial capital.

They would nationalize at least the monopolistic commanding heights of the economy (if social democratic) or nationalize far more of the economy (if socialist) in order to take full advantage of the massive economies of scale in industry, and to make sure that investments in capacity and productivity that made sense from the social point of view were made — as they would not be if large-scale industry remained private, and if it proved difficult for the private monopolists to make a profit off of such investments. And all these economic decisions would be made by democratically-elected governments responsible to an electorate that had learned by exercising power what the trade-offs were and how to choose the best path forward that led by the quickest way to utopia.

By the end of the 1970s, however, it was clear to all except blindered ideologues that something had gone very wrong with social democracy at the periphery. (And that even more had gone wrong with really-existing socialism at the periphery.)

Stable political democracy proved far more to be the exception than the rule. Authoritarian rule by traditional elites, dictatorship by impatient army officers, and charismatic populist politicians ruling by virtue of carefully-prepared and carefully-staged plebiscites were much more common than were stable parliamentary or separation-of-powers democracies. Those aspects of social insurance that were installed seemed to do more to redistribute income from (poor) rural peasants to (richer) urban workers and (rich) urban civil servants than to moderate income and wealth inequalities. With some exceptions (many of them among really-existing-socialist countries) high government spending on education and on physical infrastructure seemed to produced less in the way of actual education or infrastructure — and more in the way of sweetheart contracts to the Minister of Regional Development's nephew's cement factory — than one would have hoped.

The nationalized commanding heights of the economy turned out more often than not to become employment bureaus for the politically well-connected: under Juan Peron in Argentina the number of employees of the (newly nationalized) Argentinian railroad system close to tripled, while the number of trains and the volume of goods carried fell. It seemed that while the state was superior as an instrument of social evolution, it was not very good as a bank, or as a stock exchange, or as a nursery for inefficient enterprises.

Too-great a reliance on Keynesian policies of demand stimulation turned out to generate high- and hyper-inflation, with the recessions that came with the crash of the monetary system proving arguably larger than the booms-and-busts Keynesian policies were supposed to avoid. Import restrictions turned out to limit imports not to those of social utility, but to those profitable to the import companies owned by the son-in-law of the Vice Minister of Finance — and to the Vice Minister himself. High real exchange rates turned out to do less to amplify the purchasing power of the country abroad than to artificially shrink exports, and to divert employment and investment away from sectors of comparative advantage.

There were exceptions: places outside the core where the social-democratic program was a stunning success. India managed to hang on to political democracy (albeit with disappointing economic growth). East Asia managed to limit corruption and maximize investment in infrastructure and export capacity, achieving the fastest economic growth rates ever seen in world history (albeit with disappointingly slow progress toward political democracy, and civilian blood on the hands of the military in massacres ranging from the thousands (in South Korea) to the tens of thousands (in Taiwan) to the hundreds of thousands (in Indonesia). In Brazil rapid growth in measured GDP was associated with the most hideous income distribution ever seen. Southern Europe alone managed to "converge" to the industrial core of northwest Europe, its ex-settler colonies, and Japan.

It seemed that the key was political democracy. With stable political democracy — in France, in Italy, even in Spain after the fall of Franco — social democracy could work and achieve great successes. Without political democracy it seemed that the chances of success were low (unless somehow the poorly-understood foundations of East Asia's low corruption could be duplicated). And it also seemed that the prospects for achieving stable political democracy on the periphery were rather low. After all, France experienced its first democratic revolution until 1789, yet depending on who you talk to it was not until 1871 or 1958 or 1981 that France truly achieved stable democracy.

Hence neoliberalism as a counsel of despair. As Marx wrote, the executive branchy of the modern state is nothing but a committee for managing the affairs of the ruling class — meaning, among other things, that a democratically-elected legislative branch turns the state into something better. But the prospects for stable political democracy in the periphery are slim. And thus the government becomes the tool of the ruling class — a ruling class that may be made up of army officers, or landlords, or urban elites, or those who profit as middlemen from the traditional channels of trade and exchange — who are not terribly interested in the success of social democracy or in rapid broad-based economic growth.

Hence the policy advice of neoliberalism as a counsel of despair: get the state's nose out of the economy as much as possible. When the state is neither an instrument of positive redistribution nor an instrument of growth-boosting investment, its interventions in the economy are likely to go strongly awry. And to the extent that a reduction in the economic role of an elite-controlled state can be required as a price for rapid incorporation of an area into the global economy, such a reduction *should* be required.

A counsel of hope...

Yet neoliberalism is not just a counsel of despair, it is a counsel of hope. The hope is that the prospects for rapid market-generated economic development outside the global economy's industrial core are very bright.

The prospects for rapid market-generated economic development are very bright for three reasons. First, the productivity gap between the periphery and the industrial core has never been larger. Second, governments now have a large number of positive examples to copy (as well as negative examples to avoid) in planning market-conforming development strategies. Third, investors in the industrial core now have the confidence and the resources to materially assist in peripheral development.

First, because the productivity gap between the periphery and the industrial core has never been larger, what Alexander Gerschenkron called the "advantages of backwardness" are now uniquely great. In 1870 an Indian or a Chinese textile-making entrepreneur could perhaps quadruple labor productivity by importing the modern capital goods of the British industrial revolution. Today any entrepreneur on the periphery has the prospect of being able to amplify labor productivity tenfold or more by investing in latest-generation or latest-but-on-generation capital equipment and factory organization. The stunning multiplication of productivity in Mexican automobile manufacture gives a clue to how quickly productivity can be amplified — if the capital is there to do so.

Second, all governments everywhere are now aware — from the examples of northern Europe, southern Europe, and East Asia — of those government interventions and policies that appear to be powerful boosters of growth. They are aware of the centrality of education (especially female secondary education) in accelerating the demographic transition. They are aware of the importance of making it easy for domestic producers to acquire industrial core technology (embodied in capital goods or not). They are aware of the importance of administrative simplicity and transparency. They are aware of the value of the transportation and communications infrastructure that only the government can provide. In those areas in which the government's nose should and must stay deeply embedded in the economy, even those states controlled by elites that have only a limited interest in growth and development now have many positive models to imitate.

Third, improvements in communications and transportation have made investors in the industrial core more willing than ever before to consider placing their capital in the periphery. The pre-World War I wave of international investment was largely limited to regions in which there were lots of white guys — guys who could play polo (never mind that polo in its original form was a sport played by central Asian nomads using a goat carcass as a ball) — plus the French geostrategic commitment to Russia as an ally against the Second Reich. The U.S. benefited enormously from Britain's willingness to lend capital to industrializing America in the years before 1900. The inflow of capital cut a decade or two off of the time it took the U.S. to industrialize (and crony capitalists like Jay Gould, Colis Huntington, and Leland Stanford took British investors to the cleaners as well). Now that investors in the industrial core are willing to commit their money to regions in which there are not lots of white guys, an opportunity to speed industrialization that used to be limited to a relatively narrow part of the non-European world is now open to many more — if their governments undertake the steps needed to reassure industrial-core investors, and if those who make economic policy in the G-7 can limit the destructive effects of the financial crises generated by the manic-depressive swings of opinion in Manhattan, London, Frankfurt, and Tokyo.

A bet on globalization...

And this is where the neoliberal view of the world is weakest: in its bet on globalization — its bet that a tightly-integrated global economy, with large flows of capital and goods (and, to the extent industrial core governments permit, of labor) is a richer and faster-growing global economy. John Maynard Keynes and Harry Dexter White would disagree with the proposition that large flows of capital are good: they would call them too dangerous to be risked.

Nevertheless, neoliberals today are more impressed with the gains from capital flows than the risks. The quadrupling of real wages in Indonesia from 1965 to 1997 would have been significantly lower without capital inflows which carried technology and enabled higher domestic investment (even though real wages in Indonesia have fallen by at least a quarter since 1997). Lowered transportation and communications costs have amplified the gains from expanded international trade by an order of magnitude over the past generation. And it is next to impossible to have large international flows of goods while excluding the possibility of large international flows of capital as well. Small changes in the timing of payments and in the extension of trade credit add up to large swings in the capital account.

Thus neoliberalism is not only a bet that increasing economic integration is a good thing — that an integrated global economy will see much more levelling-up than levelling-down — but that successful stabilization policy can be pursued by the G-7 on a global level. It is thus a claim about the economic environment (that the gains from globalization are large) and about the state capacity of the G-7 (that they can successfully carry out global-level stabilization policies).

The only live utopian program...

Perhaps not all of the principles of neoliberalism are correct.

Successful development in East Asia suggests that the counsels of despair are perhaps somewhat overstated: East Asia is an example if not of successful social democracy at least of a successful developmental state. On the other hand, as Lant Pritchett has observed, there is nothing worse than state-led development led by an anti-developmental state. And pending a better understanding of what has gone right in East Asia or much greater success in institutionalizing political democracy, the risks of a government turning away from the neoliberal path and attempting to duplicate East Asian developmental states appear very high. The belief that the opportunities for market-conforming development are now uniquely great appears to be almost certainly correct. But the jury is still out on whether the free-capital-flow part of "globalization" is a good thing: the odds are 80% that the G-7 do have the state capacity to successfully manage a world economy with large-scale capital flows, but there is a 20% chance that they do not.

Nevertheless, the neoliberal program is the only live utopian program in the world today.

Opposition to neoliberalism on the left seems to call for a return to effective autarchy. But if there is one lesson from economic history over the past hundred years, it is that there has been one decade — the 1930s — when economic autarchy was the road to relative prosperity, while there have been nine decades in which the more open to trade a country's economic policy, the faster has been economic growth. Opposition to neoliberalism on the left seems to call for a return to state control of the economy — to the pattern of Peronism or of the PRI — in the hope that this time the state will be not the tool of elites with little concern for development and growth but instead the faithful servant of the interests of the masses.

That is not very likely. The state can be the servant of the people only if political democracy is well-established, and not always then. To place one's chips on the maximization of the power of a not-very-democratic and not-very-developmental state does not seem a promising path for either democratization or successful industrialization. It seems to embody a remarkable unwillingness to learn from world history since the end of World War I, and an ideological-blinded refusal to ever mark one's beliefs to market.

Opposition to neoliberalism on the right seems based on a fear that neoliberalism will bring with it a breakdown of social order: peasants will no longer fear landlords, workers will no longer be the clients of bosses or of the leaders of government-sponsored puppet unions, and voters will no longer respect the views of notables.

All the rest of us certainly hope that the right-wing opponents of neoliberalism are correct, and that neoliberalism this generation will begin structural transformations that will make social democracy on the periphery possible next generation.

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