December 20, 2012 6:25 pm
A case remains for economic liberalism
The philosophy’s basic tenets hold sound despite the financial crisis
This is a good time to ask what is left of an outlook known to its enemies as neoliberalism and by at least some of its friends as just economic liberalism. One cannot be too careful in choice of wording.

For neoliberalism was originally the self-chosen name for a group formed just before the second world war around the US commentator Walter Lippmann and which advocated, among other things, making greater use of market forces in economic policy. It has only more recently acquired pejorative associations.

Roughly speaking, the quarter century after 1945 was not a promising time for economic liberalism – except perhaps in West Germany where Ludwig Erhard was the guiding spirit of the so-called economic miracle. The tide turned towards economic liberalism in the last quarter of the century, symbolised by the leadership of Ronald Reagan and Margaret Thatcher in the 1980s.

The approach lingered on even after the departure of these charismatic leaders. While Tony Blair and Bill Clinton may have come from a different end of the political spectrum, they made no attempt to reverse course. The traumatic event was of course the financial crisis that broke out in 2007-08 and administered a fatal blow to economic liberalism.

Or did it? As far as normal goods and services are concerned, there is still a great deal to be said for giving a leading role to prices and profits. But for financial markets economic liberalism, at least in the form we have known it, has proved fatally flawed. The tendency of capitalist economies to boom and bust is intimately connected with that failure. As almost every government and central bank is committed to its reform, I would for the present concentrate on other aspects.

The basic case for competitive markets is, first, that they provide consumers with what they wish to have rather than with what some authority thinks would be good for them. Second, they provide some guidance on how goods and services should be produced.

It would not have been sensible to build the Great Wall of China with 21st-century electronic equipment when there were millions of underemployed labourers ready to hand. Thirdly, allowing innovators to keep some of the fruits of their activities may provide some incentive to progress. In a priori theory, competitive markets do not have to be capitalist ones. There have been numerous blueprints, from market economies based on state ownership to workers’ co-operatives. But they have not really got off the ground.

An example of misunderstanding is a book that appeared this year with the strange title Masters of the Universe by Daniel Stedman Jones. It was about free-market economists, such as Friedrich Hayek and Milton Friedman and their supposedly malign influence over governments. It is very thorough, honest according to its lights, but thoroughly misleading.

For the thinkers in question are not just politicians in disguise. So far as they had an overriding policy or agenda, it was to reduce the influence of coercion in human affairs. What they certainly did not wish to do was to rule the universe either directly or through their political disciples.

There are, of course, numerous examples of market failures. There are the famousexternalities”. Factories do not have to pay for the damage caused by smoking chimneys. Owners of smart front gardens receive no benefit from the enjoyment conferred on passers-by.

There is also always the temptation of successful capitalists to try to become monopolists. There are correctives using markets and prices. Examples range from the auctioning of planning permits to anti-cartel legislation. Free trade is often the most effective corrective.

Above all, however, critics of market failures are offset by political failures. Governments often have neither the incentive nor the knowledge to impose effective correctives.

The biggest flaw in market liberalism is in the distribution of income and wealth. For a long time the degree of concentration fluctuated around a fairly stable rate. But in the past two or three decades it has increased markedly, making it much more difficult for supporters of capitalism to argue that a rising tide floats all boats. We could live with this situation in which the top 1 per cent of US families owned 7-8 per cent of US incomes, as in the early 1980s, but hardly when they are getting 18 per cent as they are said to do now. The respectable academic response is to try to correct the situation through the tax and social security systems. But this may be more difficult in a world struggling to achieve genuine mobility of labour where emigrants could overwhelm the redistributive apparatus.

This has not happened yet. But we need to prepare. The hard truth is that tensions can develop between free migration and other economic freedoms. But for all the looming problems, it is still untrue that the nanny state knows best.

Copyright The Financial Times Limited 2012.

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