Daily Market Update

A Critique of the Neo-liberal Agenda

Essay by Meghan Brown

“If the story of the past quarter of a century has a one-line plot summary, it is the rediscovery of market capitalism.” – Alan Greenspan, The Age of Turbulence, p.14 For the past thirty years, neo-liberal economic thinking has been the dominant orthodoxy governing policy and shaping development. Born from Adam Smith and his ideas of the ‘invisible hand’, this theory prevails in many well-connected and highly influential institutions such as the International Monetary Fund (IMF), the World Bank (WB), and the US Treasury, together known as the ‘Washington Consensus’. This essay will explore the theories behind neo-liberalism, which contend that unfettered markets provide the best arrangement for the allocation of resources and to which prominent thinkers such as Jagdish Bhagwati, Thomas Friedman and Martin Wolf subscribe. Neo-liberal ideology is the main orthodoxy governing world trade institutions, and the Washington Consensus acts as the key site in propagating, regulating, and maintaining it. I will show how these theories have been used as a strategy in reducing global poverty and inequalities. In adopting the neo-liberal “shock therapy” policies of privatization, trade liberalization and deregulation in the 1990s Russia regressed in its development, and will be seen as a case study in how neo-liberal principles have failed. Juxtaposed with the successful development of China, which rejected the Washington Consensus’ “one-size-fits-all” policy prescription, the shortcomings of neo-liberal economic thinking will become apparent. Neo-liberal theories will be attacked, using evidence from Joseph Stiglitz’s research on the IMF in illustrating the shortcomings of a neo-liberal ideology. Neo-liberalism will be critiqued on three grounds: firstly, for not recognizing the management of policies as an issue; secondly, for lacking transparency and accountability; and thirdly, for the context to which such policies are being applied. Further, the gapping holes in the neo-liberal economic model will become apparent as parallels are drawn between neo-liberal development economics and how the same neo-liberal policies have caused the current credit crunch and nascent economic recession.

I. Explanation of Neo-liberalism

As the world’s first liberal economist, Adam Smith’s work The Wealth of Nations introduced ideas of the invisible hand in which government plays no part in the free reign of the marketplace. Smith argued that the market was best left to itself governed by the natural laws of supply and demand. Today’s neo-liberals derive their notions of economic policies from classical liberal economists of the 18th and 19th centuries such as David Ricardo and Thomas Malthus. Such thinkers agree on three basic principles that lay at the foundation for the neo-liberal ideology. First is the idea of trade liberalization, which seeks to eliminate any barriers that would inhibit the free movement of goods to trade. Neo-liberals oppose restrictions placed on trade as it is believed that it hinders the free movement of goods in a market economy, which left unfettered, provides the optimal allocation of resources. Government imposed tariffs, subsidies, and all other regulation which alters the “true market price” are seen as barriers to free trade. In conjunction with liberalization, proponents of neo-liberalism argue for deregulation. This often means a depletion or termination of intervention of regulated trade. Government involvement in the market is seen as a further barrier in preventing the natural forces of supply and demand to take hold and allocate goods to the optimal potential. Examples of such measures which regulate trade include government sponsored social protections such as food assistance programs, welfare subsidies, and price controls, especially on essential food staples like wheat and rice. These are all considered market frictions which “distort market processes” (Peine and McMichael, 22). Therefore, neo-liberal rhetoric advocates the weakening of barriers which regulate trade, and that government step back from its involvement in the market. Lastly, neo-liberals call for privatization. In making the global market more autonomous by a weakening state influence, private firms step in and increase their influence. In deregulating market governance from public influence and liberalizing trade, the global market becomes privatized to a greater extent. The neo-liberal wave of thought came to great prominence after the Cold War with former communist countries in Eastern Europe acting as a tabula rasa for neo-liberal economic theorists to test textbook economics on real life. Since then, this viewpoint has dominated powerful institutions such as the Washington Consensus and has been carried with a missionary zeal to many more influential organisations where it operates as theological dogma.

II. Globalization alone does not reduce poverty; management as an issue

Globalization, it is argued has the power to lift people out of poverty by means of modern technology and international trade, in addition to social benefits from living in an open and borderless society. However, the problem according to Sen and Stiglitz is that there exists an inequality in the institutional arrangements, which do not allow for the benefits of globalization to be widely dispersed. Supporters of neo-liberal economic globalization argue that free trade and a weakening in borders will reduce the amount of global inequality. Globalization therefore is associated with generating wealth and providing access to move people out of poverty that previously did not have the opportunity to do so. Jagdish Bhagwati argues that such a correlation is simple: Globalization helps reduce poverty and consequently income expansion reduces poverty (Bhagwati, 2005). However, this argument is entirely simplistic. If poverty reduction were that simplified, all globalised parts of the world would be poverty-free! In supporting this argument, Bhagwati cites two sprawling nations: India and China. In opening up trade barriers since the 1980s, they have both experienced increased economic prosperity. However, both countries still experience significant poverty, and the disparities between rich and poor are extremely widespread. Without proper institutions for managing the effects of a globalised economy, an uneven sharing of the benefits is created. Currently, there is no effective system in place which acts as a checks and balancing system for global governance. The main problem associated with neo-liberal economics is management. Neo-liberals do not recognize management of economic policies as an issue. Reducing poverty based on the effects of globalization alone is a weak argument, as Martin Wolf notes. He believes that the function of the state is imperative in order to provide the prerequisites or conditions such as infrastructure, education, and laws before changes can successfully take place (Wolf, 2004). The state plays a crucial role in managing these conditions inside country’s borders. In order to operate on the globalised world stage, such conditions must be met. Therefore, it cannot be argued, as neo-liberals often do that globalization singularly reduces poverty. The success of a globalised economy depends on the management of underlying institutional framework. As Amartya Sen states, ‘The crucial role of the markets does not make the other institutions insignificant, even in terms of the results that the market economy can produce.’ (Sen, 2002: The American Prospect). The market economy should of course be used; however the success of it depends highly on social, political, and institutional framework that operates on a national and global scale. The notion that economic globalization alone reduces poverty, and consequently propels an impoverished nation into prosperity can be dispelled by the case study of Russia. Regulations and institutions in Russia were built upon the old command centered regime, a completely polar way of operating as opposed to a market economy. While there were banks, they only functioned when the centrally planned government told them what to do. Laws to govern competition, an integral part of trade, did not exist. Further, social securities such as unemployment, low-income housing and disability benefits were absent under a communist regime, as everyone was given housing, retirement benefits and a secure job. In imposing privatization, liberalization and deregulation measures, Washington Consensus experts tried to jump start a market economy without accounting for the underlying social and institutional framework for development. Because development officials were so far removed from the localities in which they implemented policies, they merely assumed that the signified notion of “bank” meant the equal function of their notion: a Western bank. This process of assuming and shortcutting underlying institutions to reach the optimal creation of a market economy lead neo-liberal policies to fail. The measures of liberalization sank its currency into worthlessness, destroyed local industries, and sold off valuable assets to a small group of powerful interests (Stiglitz, 2002). Neo-liberal thinkers believed that liberalization alone would save Russia, and in doing so, failed to account for the institutions underlying them such as banks and laws. In their race to hastily apply neo-liberal measures, such officials failed to account for the underlying framework for development. Neo-liberal economics’ narrow approach to development and the idea that globalization alone reduces poverty alone can be dispelled by the post-Washington Consensus case of Russia. This phenomenon is not only exclusive to the world of developing countries but is evident in the current financial crisis, touching the lives of Western First World citizens. Several decades of neo-liberal free market fundamentalism has spurned rapid growth and the uninhibited reign of free market liberalism. The ascent of free market capitalism has been partly fuelled by cheap money, low interest rates and a housing and credit bubble. However, lack of regulation and management across the financial world has lead to the destruction of the global economy. Little supervision allowed reckless lending practices. Borrowers, unable to pay the complex financial payment packages they were sold but could not afford, suddenly defaulted on loans. As a result, creditors such as banks, pillars of the financial world, have crumbled. In the past year alone, the world has witnessed the downfall of trusted global institutions such as Lehman Brothers, Bear Stearns, and Northern Rock. These institutions, uninhibited by regulations, went off the rails. And, in doing so, have left their customers vulnerable to the inherently instable and volatile nature of the free market. The crisis has been propelled by many causes but the front-runner emerges as too little regulation, which could have prevented the spectacular burst of the credit and housing bubble. “Lax oversight did indeed allow financial firms to borrow far more than was prudent to make bets that have now gone sour. Tougher regulation might have prevented this” (“The Politics of Despair”, 45). Today’s financial world is characterized by its global nature: interwoven, complex and knowing no boundaries. The credit crunch’s contagion has left no corner of the globe untouched. Yet there is no overarching global governance system which regulates its activities. “What separates the winners from the losers is not models but management” (“No Size Fits All”, 11). From the evidence we are beginning to experience with the current global slowdown, it can be said that neo-liberalism needs management. Therefore, the neo-liberal contention that markets alone have the ability adequately align social interests is erroneous. Without proper management, neo-liberalism does not work.

III. Lack of transparency; accountability

Although global institutions such as the World Bank and the International Monetary Fund are publicly funded by taxpayers from countries around the globe, there is little accountability. Decisions are often made without public debate, taking place behind closed doors. Member states of both the IMF and WB contribute significant sums of money to the global funds however, individual member states and indeed the constituencies they represent are kept out of the discussion and debate when decisions are made. The policies prescribed by the Washington Consensus carry tremendous implications for the citizens of the lives they touch however, such peoples have no input. Joseph Stiglitz routinely observed during his time as chief economist at the World Bank of the way in which IMF officials would only meet with other top officials in the banking or government sectors when visiting countries they were implementing policies for (Stiglitz, 2002). Native peoples are kept in the dark therefore about the life changing policy measures which are thrust upon them. Not only is accountability absent externally but is equally missing within these global organizations. Officials yielding power and decisions deliberately shielded themselves from criticism within the organization. Stiglitz gives a first-hand account as he writes, “It was maddening, not because of the IMF’s inertia was so hard to stop but because, with everything going on behind closed doors, it was impossible to know who was the real obstacle to change”(Stiglitz, 2000: 57). Secluded from creative criticism from within, in conjunction with a lack of democratic accountability from its global constituents, the Washington Consensus is thus held responsible to no one. A lack of transparency in the financial sector can be said to be responsible for the nascent financial meltdown. The current economic recession (or impending depression) is partly a result of the opaque and complex nature of financial firms, which do not voluntarily disclose all of their activities. While sometimes there are great gains to be made clandestinely, a lender greatly loses when such secret transactions go wrong. The credit crunch, for example, was caused by lenders, in particular in North America, who sold mortgages to high-risk borrowers. These debts were packaged and resold over and over again on the global market. Opaque and complex, these high-risk packaged schemes turned bad when borrowers defaulted on their sub-prime mortgages. Because of the complexities involved in such investments, investors were unaware or kept in the dark about the kinds of risky investments they were engaging in. The lack of information lead lenders to make risky decisions. Unable to distinguish between healthy and toxic financial institutions, creditors invested in firms they mightn’t have otherwise. Incorrect or imperfect information fuelled the credit and housing booms in which investors were not made aware of the high stake risks that were at play. The rise of free market liberalism has kept regulation at bay to a certain extent, with financial firms being asked to produce minimal evidence of their activities. But now as toxic and incredibly risky lendings are defaulting in a harsh and unforgiving economic climate, the importance of greater transparency is painfully evident. Increased regulation which would demand more transparency related to pay, lending practices, earnings etc would contribute to a sounder financial system. Making accounts and activities more transparent would allow for knowledge to be widely available and encourage financial accountability by way of creative criticism by actors outside of such flows. As Main Street is now being asked to bail out Wall Street’s profligacy, who were once deemed too big to fail, we must have regulatory standards that makes their activities accessible to tax paying citizens, who now acts as their lifeline. Markets on their own do not produce transparency. Therefore neo-liberalism must include key policy changes which demands more disclosure. In turn this would ensure greater accountability and in the long run, a more sustainable financial system.

IV. One-Size-Fits-All

The third main problem associated with neo-liberalism is that it very often fails to recognize the differing context in which policies are being implemented. The policies adopted by countries under the guidance of the neo-liberal institutions of the Washington Consensus are often ‘cookie-cutter’ adaptations of textbook economics, imposed with no differentiation from one developing country to the next. As previously suggested, officials operating as policymakers are far removed from the local circumstances, often never properly seeing the country to which they are advising policy prescriptions for. Stiglitz gives an anecdote of an IMF official who “copied large parts of the text for one country’s report and transferred them wholesale to another” (Stiglitz, 2000: 58). Lacking local knowledge and indeed local considerations (such as differing institutional arrangements, varying modes of governance) led to failed policies which did not take into account local contexts and customs. The importance of recognizing that the same conditions do not work everywhere cannot be understated. As Stiglitz states, ‘The officials who applied Washington Consensus policies failed to appreciate the social context of the transition economies’ (Stiglitz, 2002: 160). In doing so, countries such as Russia regressed in development because the policies applied by neo-liberal thinkers did not fit the Russian context, which will now be described.

V. The tortoise and the hare

In the 1990s, countries in transition from former communist based regimes such as Russia’s were placed under severe pressure by the Western led Washington Consensus to fulfil the neo-liberal goals of privatization, liberalization and deregulation. But because the Russian institutional infrastructure was lacking (which Washington Consensus policy makers failed to note), the policy prescription of instant liberalization from Russia’s centrally planned economy to a market-based one lead to a spiralling series of domino like problems. First, freeing prices lead to rapid inflation, which wiped out savings. Trade liberalization brought in cheap foreign imports but the majority of people, with their savings gone, couldn’t afford to pay. Further, in encouraging rapid trade liberalization local industry, which could not compete with cheap subsidized imports from abroad, was devastated. “Russia was flooded with imports, and domestic producers were having a hard time competing” (Stiglitz, 2002: 145-146). The collapse of local industries had a knock on effect throughout a community and damning social consequences; people found themselves without jobs, unemployment rose, poverty widened, and inequalities entrenched. In addition, as imports rise more rapidly than exports counties adopting neo-liberal development regimes face increasing trade deficits, which further impoverishes a nation into long term debt and consequently, does little to support their development (Khor, 2008: 222). Russia borrowed billions from the IMF and yet even after it privatized and sold off all of its assets, it was so indebted that it couldn’t afford to pay its citizen’s pensions (Stiglitz, 2002). Liberalization makes sense but only after a country’s infrastructure has matured in such a way that it is able to complete. Of the three-prong prescription package, neo-liberalists pushed for privatizing Russian state enterprises. As an effect of liberalization policies, which were introduced simultaneously with privatization, high inflation ensued. This had depleted savings of ordinary Russians. When Washington Consensus officials with little knowledge other than their “one-size-fits-all” approach to development encouraged the Russian government to sell off its assets, the majority of people, now with their savings wiped away, could not afford to buy the new businesses, property and other various ventures up for sale (Stiglitz, 2002). Oligarchs snapped up properties and state officials embarked on a “family and friends” program, which saw the transfer of former state enterprises to close relations (Stiglitz, 2002). Rather than dispersing wealth in the hands of many, privatization concentrated it into the hands of a few. Then, as the rapid run of inflation became apparent, the IMF, in its mission to offset inflation, lowered it to such an extent that it lead to outrageously high interest rates. The effect of this was that new growth and development was discouraged. Private enterprises and innovation, which neo-liberal policies sought to encourage were only hampered by high borrowing rates. This “one-size-fits-all” approach to development implemented by the Washington Consensus was blind to the country’s particulars in understanding that “shock therapy” liberalization and simultaneous privatization policies would have malignant effects. An understanding of the local context would have allowed development officials to see that liberalizing the Russian economy at the same time of encouraging the state to privatize would have lead to better policies and indeed development. Instead of focusing money and resources on developing a country based on its individualized composition, neo-liberal policy makers pushed “cookie-cutter” structural alignment trajectories from a Western paradigm, which ignored the Russian context. This is evident as economists and other researchers working in these institutions lack knowledge about the country they are advising policies for. By implementing a ‘one-size- fits-all’ approach, neo-liberal policies ignore specific differences in a country’s composition, which only lead to failed development policies. Therefore, in prescribing remedies to developing countries, neo-liberal proposals tend to leave out room for cultural differences, which strongly affect a country’s development.

V. The Great China

While there is no oracle to tell us what would have happened had Russia not followed Washington Consensus advice we can certainly look to successful cases which did not accept Western-led neo-liberal knowledge. When the People’s Republic of China opened up its markets in the late 1970s, its development followed a different trajectory. In taking stock of policies advised by Western, neo-liberal institutions, Chinese officials were highly selective in choosing the ones best for their own development. China began its transition from a centrally planned economy to a market based one beginning with the partial (rather than rapid) privatization of agriculture. The collective system was dismantled on a trial basis and then widely adopted by its constituents who viewed it as a great success. Chinese officials implemented a gradual approach in moving from one system to another and in doing so have had a much more stable transition than Russia, as well widespread support by its people. China’s iconoclastic case shows us that success depends on an understanding of local knowledge rather than “one-size-fits-all” blueprints from abroad. Rodick agrees in saying, “The initiating reforms instead tend to be a combination of unconventional institutional innovations with some of the elements drawn from the orthodox recipe” (Rodick, 2002: 7). The next phase of China’s development involved the employment of a two-tiered pricing system which allowed a gentle switch from a set pricing regime to a market responsive one. This involved a mechanism by which a firm continued to produce under the quota established by the old centrally controlled regime while anything produced over this amount was priced according to the free-market. In this way China was able to avoid the failures of the Washington Consensus blunder of rapid liberalization which was responsible for rampant Russian inflation and the disappearance of savings. China’s success comes out on top. Compared to Russia, which in the 1990s declined by an average rate of 5.6%, China grew at an average of over 10% (Stiglitz, 2002: 181). It was China’s recognition of its differing context in employing policies which fit its individual needs which is credit to its success. “One attribute of the success cases is that they are ‘homegrown,’ designed by people within each country, sensitive to the needs and concerns of their country” (Stiglitz, 2002: 186). Surely China shows us that there are alternative ways of development which fall outside of the harsh textbook economics the IMF and other global institutions propagate. This startling juxtaposition between the highly successful transition economy of China, which opposed recommendations made by neo-liberalists, and the further impoverished nation of Russia which blindly followed the IMF’s recipe for economic success, demonstrates how neo-liberalism fails.

VI. Conclusion

The foundation of neo-liberal economic thinking rests on the idea that an unhindered market economy is the best and only arrangement for solving economic development. It provides developing nations the ability to trade in a globalised economy while also reaffirming liberal democratic ideals. Neo-liberal economic thinkers have dominated development policies in recent years within organizations such as the International Monetary Fund and World Bank. Using Joseph Stiglitz’s damning critique of how neo-liberal economics were used during Russian economic development, this essay has attempted to show the three main problems associated with this school of thought: not accepting management of such policies as an issue; the lack of transparency in decision-making which does not make global institutions accountable; and, applying a ‘one-size-fits-all’ model to all developing regions without accounting for differing contexts. These three problems have been explored under the framework of poverty and expanded to the current global economic crisis, which have stemmed and are a result of neo-liberal economics’ failure to address these shortcomings.


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