Political debates often don’t take on quite the sophistication and complexity of the intellectual debates that lie behind them and, in part, motivate them. With the Iron Curtain coming down in 1991 and China declaring that it, too, was going to be a market economy, albeit “with Chinese characteristics” (whatever that meant), there was a broad consensus that the extremes of socialism/communism with government ownership (and implicitly, control) of everything, on the one hand, and a totally unfettered market (of the kind that the Mont Pelerin Society had been advocating), on the other, were things of the past.
Political scientist and economist Francis Fukuyama could even celebrate this as “the end of history,” as our understanding of economic and political systems had converged into the “correct solution”—market economies and liberal democracies.
There was a search for the best “third way” between the far left and far right, since there was a lot of space between the extremes of the Mont Pelerin Society and communism. It made a big difference exactly where between the two one situated oneself. Politically, this was reflected in battles within and between the center left and center right.
The political debate shaped up most clearly during the presidency of Bill Clinton—for instance, between those in Clinton’s administration focused on the environment, inequality, and making the economy more competitive, and those focused on debt, interest rates, deregulation, liberalization, and growth. For the most part, the latter group won out.
The system that evolved in the last quarter of the twentieth century on both sides of the Atlantic came to be called neoliberalism. “Liberal” refers to being “free,” in this context, free of government intervention including regulations. The “neo” meant to suggest that there was something new in it; in reality, it was little different from the liberalism and laissez-faire doctrines of the nineteenth century that advised: “leave it to the market.”
Indeed, those ideas held such sway even into the twentieth century that, decades earlier, the dominant economists had said “do nothing” in response to the Great Depression. They believed the market would restore itself relatively quickly as long as the government didn’t fiddle around and mess things up.
What really was new was the trick of claiming neoliberalism stripped away rules when much of what it was doing was imposing new rules that favored banks and the wealthy.What really was new was the trick of claiming neoliberalism stripped away rules when much of what it was doing was imposing new rules that favored banks and the wealthy. For instance, the so-called deregulation of the banks got government temporarily out of the way, which allowed bankers to reap rewards for themselves. But then, with the 2008 financial crisis, government took center stage as it funded the largest bailout in history, courtesy of taxpayers.
Bankers profited at the expense of the rest of society. In dollar terms, the cost to the rest of us exceeded the banks’ gains. Neoliberalism in practice was what can be described as “ersatz capitalism,” in which losses are socialized and gains privatized.
Neoliberal economists constructed a theory to support their views, not surprisingly called neoclassical economics. The name evoked nineteenth-century classical economics, with the “neo” emphasizing it had been put on firmer foundations, which in practice meant putting it into mathematical scribbles.
Some neoclassical economists were slightly schizophrenic, recognizing that markets often don’t generate full employment on their own, so Keynesian policies are sometimes required; but once the economy is restored to full employment, classical economics prevails. This idea, pushed by my teacher Paul Samuelson, was called the neoclassical synthesis. It was a highly influential assertion, with no basis in either theory or empirics.
The call for a return to liberalism with the new name neoliberalism, in the middle of the last century, flew in the face of what had happened during the Great Depression. It was akin to Hitler’s Big Lie. In light of the Great Depression, the economic argument that markets on their own were efficient and stable seemed absurd.
(It was a Big Lie in another sense: the reality was that the government was taking on a large role, no matter how one measured it—share of GDP or share of employment. Over time, democratic political systems had identified areas in which markets were not delivering what societies wanted and needed, like retirement benefits, and countries had figured out ways of doing so publicly.)
Belief in the market (and the materialism associated with it—the more GDP, the better) became, for many around the world, the late-twentieth-century religion.But memories are short, and a quarter century after that dramatic event, with the trauma of World War II and the beginning of the Cold War intervening, the Right was ready to move on and once again celebrate the alleged efficiency of free markets. When confronted with theory and evidence to the contrary, they closed their eyes and reasserted their faith, as I saw personally in my repeated interactions with Milton Friedman and his colleagues, both at the University of Chicago and at their West Coast citadel, the Hoover Institution, on the Stanford University campus.
Belief in the market (and the materialism associated with it—the more GDP, the better) became, for many around the world, the late-twentieth-century religion, something to be held on to whatever the theory or the evidence to the contrary.
When the 2008 financial crisis happened, it seemed impossible that these conservatives would hold on to their market fundamentalist religion, that markets on their own were efficient and stable. But they did, which confirmed that it was, in a sense, a fundamentalist religion, the truth of which is virtually unshakable by reasoning or, as here, events.
And they continued to believe in it even as the failures of neoliberalism described below became more and more evident.
They closed their eyes not only to the big failures but to the smaller ones that make life for so many so difficult—airlines with myriad delays and lost luggage, cell phone and internet services that are unreliable and expensive, and in the US, a healthcare system that, while the most expensive by far in the world, is impossible to navigate and results in the lowest life expectancy of any of the advanced countries.
In this new religion, markets are always efficient and government always inefficient and oppressive. We simply weren’t appreciating fully the efficiency benefits of the two-hour holds on the telephone with our internet provider or our health insurance company.
There was another way in which this “economic religion” was similar to more conventional religions: proselytization. Conservatives’ faith was assiduously spread through the media and, to a considerable extent, through higher education, effectively ushering out of the public and political zeitgeist any remnants of an alternative and more humane economic vision that had first emerged in the 1930s and then flowered again in the more turbulent period of the late 1960s and early 1970s.
There was still one more way in which neoliberalism was like a fundamentalist religion: There were pat answers to anything that seemed contrary to its tenets. If markets were unstable (as evidenced in the 2008 financial crisis), the problem was the government—central banks had unleashed too much money. If a country that liberalized didn’t grow in the way the religion said it should, the answer was it hadn’t liberalized enough.
As we have seen, with a post-Depression generation in charge in the last part of the twentieth century, governments around the world adopted one version or another of neoliberalism. It pleased the capitalists, and the simplistic argument that free markets would deliver both economic success and freedom seduced large numbers of people. I’ve highlighted the role of the Right in pushing the neoliberal agenda; but the Right was enormously successful in creating the mindset of the time. I’ve described the embrace of neoliberalism by Clinton, Schröder, and Blair.
There were, let me emphasize, large differences over the details of neoliberalism between the center-left and center-right that dominated political and economic debates, especially in rhetoric. The former tried to put a human face on the reforms, asking for assistance for those who lost their jobs as a result of trade liberalization. The latter focused on incentives, worried that any adjustment assistance might weaken efforts of people to do their own part.
Only around half of Americans born after 1980 could hope to have earnings higher than their parents (down from ninety percent for the cohort born in 1940).The Right talked about trickle-down economics: if we made the economic pie larger, all would eventually be better off. Democrats and European social democrats weren’t so sure that trickle-down would work, or work fast enough. But in the end, in spite of these differences and much rhetoric, the center-right and the center-left were both wedded to neoliberalism.
We’ve now had forty years of this neoliberal experiment that began under Reagan and Thatcher. Its rosy promises of faster growth and higher living standards that would be widely shared have not been borne out. Growth has slowed, opportunity diminished, and the fruits of what growth has occurred have gone overwhelmingly to the people at the top.
The results were perhaps the worst in the United States, with its greater reliance on markets and where financial liberalization was taken to the most extreme. The country experienced the largest economic recession in three-quarters of a century with the 2008 financial meltdown, a crisis that it exported to the rest of the world. By the early years of this century, America had become the country marked by the highest level of inequality and some of the lowest levels of opportunity of any of the advanced countries. Wages at the bottom, adjusted for inflation, hovered at the same level that they had been more than a half century earlier.
The American Dream had become a myth, with the life prospects of a young American more dependent on the income and education of her parents than in other advanced countries. Only around half of Americans born after 1980 could hope to have earnings higher than their parents (down from ninety percent for the cohort born in 1940). This loss of hope also had political consequences, witnessed so clearly in the election of Donald Trump as president.
Statistics do not tell the full story. That unfettered markets, or even inadequately regulated markets, lead to socially undesirable outcomes should be obvious to anyone living through the late twentieth or early twenty-first century.
Think of the opioid crisis, created in no small measure by drug companies and pharmacies exploiting people in pain; think of the cigarette companies making addictive, lethal products; think of the multiple scams that prey on the elderly and others; think of the food and drink companies pushing their unhealthy products so aggressively and for so long that the country faces an epidemic of childhood diabetes; and think, too, of the oil and coal companies making billions of dollars as they endanger the planet. It is hard to think of a corner of our capitalist system in which some form of scam or exploitation is not going on.
It is not just the costs imposed on those directly experiencing the dark sides of capitalism; all of us are constantly on guard lest we be taken advantage of. The economic costs are large; the costs to our psyches far larger. They reflect systemic failures with major consequences—for example, the relatively poor health conditions (compared with other advanced countries) noted earlier.
The consequences of the neoliberal project elsewhere in the world are no better. In Africa, Washington Consensus policies led to a process of deindustrialization and a quarter century of near-zero growth in per capita income. Latin America experienced what is widely called the Lost Decade in the 1980s. In many countries, the rapid influx and then outflow of capital under the policies of capital market and financial market liberalization led to crisis after crisis—more than a hundred around the world.
Friedman and Hayek were the intellectual handmaidens of the capitalists.The inequalities that marked the US were a shadow of what occurred elsewhere. Foisted on the countries of the former Soviet Union, Washington Consensus policies led to deindustrialization. A once-powerful Russia was reduced largely to a natural resource economy roughly the size of Spain’s, controlled by a small group of oligarchs who resented how the West had guided the country’s path away from communism. It set the stage for the rise of Putin and everything that followed.
But what about the theory that markets would lead to efficient outcomes? Conservative economists picked up on Adam Smith’s “invisible hand” but left behind the qualifications he put on the idea. When economic theorists attempted to prove that competitive markets were efficient, they ran into a dead end. The conclusion was only true under very limited conditions, so limited as to be irrelevant to any economy. Indeed, these attempts to prove that the market was efficient highlighted the limitations of the market—what came to be called market failures.
Such failures include limited competition (where most firms have some power to set their prices); absent markets (one can’t, for instance, buy insurance for most of the main risks we face); and imperfect information (consumers don’t know the qualities and prices of all goods in the market, firms don’t know the characteristics of all their potential employees, lenders don’t know the likelihood that a potential borrower would repay, and so on). So committed were conservative economists like Friedman to their ideology that they were reluctant to accept these fundamental theoretical results.
I recall a conversation with Friedman at a seminar I gave in the late 1960s at the University of Chicago showing the failure of markets to handle risk efficiently—a result I established in a series of papers that have not been refuted in the half century since they were written. Our conversation began with his assertion that I was wrong, and that markets were efficient. I asked him to show me the flaws in my proofs. He reverted to his assertion and his faith in the market. Our conversation went nowhere.
Though writing earlier than Friedman, Hayek’s reasoning in many ways was more subtle. Hayek seems to have been more influenced by evolutionary thinking, that somehow the struggle for survival resulted in the “fittest” firms (those that are most efficient and most successful at meeting consumers’ needs) outlasting their competitors. His analysis was even less complete, based simply on the hope (or the belief) that evolutionary processes would yield desirable outcomes.
Darwin himself had realized that this might not be the case, that the experiments on the isolated Galápagos Islands had led to quite different, and sometimes rather bizarre, evolutionary outcomes. Today, we realize that there is no teleology in evolutionary processes. Put in economic terms, that there can be no presumption that they result in the overall long-run dynamic efficiency of the economy.
Quite the contrary. There are well-known shortcomings, of which the major failures described in earlier paragraphs are only the most obvious. Natural selection does not necessarily eliminate the least efficient. Firms that die in an economic downturn are often as efficient as those that survive; they simply had more debt.
Friedman and Hayek were powerful rhetoricians who made seemingly persuasive arguments. The strength of modern mathematical economics is that it forces greater precision in both assumptions and analyses, which is also its weakness because such precision requires simplifications that may ignore essential complexities.
Economic theorists, working in both the equilibrium tradition (to which Friedman belonged) and the evolutionary one (to which Hayek belonged) have shown that their analyses were incomplete and/or incorrect, as I’ve just explained. Economic theory predicted that unfettered markets would be inefficient, unstable, and exploitive, and, without adequate government intervention, would be dominated by firms with market power that would give rise to large inequalities. They would be shortsighted and not manage risks well. They would spoil the environment. And shareholder value maximization would not, as Friedman claimed, lead to the maximization of the well-being of society.
These predictions by the critics of unfettered markets have been validated. Looking back on their economics from the perspective of three-quarters of a century of research, Hayek and Friedman simply didn’t get it right and, unfortunately, didn’t even set the right research agenda. They were great polemicists whose ideas have had, and still have, enormous influence.
How could such bright minds have gotten it so wrong? The answer is simple. Friedman and Hayek examined the economy from an ideological perspective, not a dispassionate one. They attempted to defend unfettered markets and existing power relations, including as reflected in the distribution of income and wealth.
They were not really attempting to understand how capitalism actually worked. They assumed markets were essentially always highly competitive, with no firms having power to set prices, when it was obvious that critical markets were not competitive. They assumed in much of their work that there was perfect information, or at least that markets were informationally efficient—conveying costlessly and instantaneously all the relevant information from the informed to the uninformed and aggregating all the relevant information to be perfectly reflected in prices.
These were convenient assumptions, which helped to get the desired results on the efficiency of the market economy. And they were convenient in another way: they simply didn’t have the mathematical tools necessary to analyze markets with imperfect information. But when shown analyses based on those more advanced tools, which showed that markets weren’t and couldn’t be informationally efficient, they and others in their camp looked the other way. They didn’t want to engage with analyses that might lead to a conclusion that differed from their unfailing allegiance to the market.
Friedman and Hayek were the intellectual handmaidens of the capitalists. They wanted a smaller role for government and less collective action. They blamed the government for the Great Depression (poorly managed monetary policy) and for every other seeming failure in the economy. And they claimed that government intervention in free markets was itself the road to totalitarianism, ignoring the historical reality of the economic conditions that had led to fascism and communism.
It is too little government—government not doing enough about the critical problems of the day—not too much government that has led to populism and has repeatedly set society on the road to authoritarianism.
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Excerpted from The Road to Freedom: Economics and the Good Society by Joseph E. Stiglitz. Copyright © 2024 by Joseph E. Stiglitz. Used with permission of the publisher, W. W. Norton & Company, Inc. All rights reserved
