The US Economy and Neoliberalism

Alternative Strategies and Policies

Nikolaos Karagiannis, Zagros Madjd-Sadjadi, Swapan Sen, Nikolaos Karagiannis, Zagros Madjd-Sadjadi, Swapan Sen

• Publisher: Taylor & Francis
• Year: 2013
• Print ISBN: 9780415645058
• eBook ISBN: 9781135097592
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

In recent times, policy makers, scientists, academics and commentators have become increasingly nervous about the US economic downturn. Discussions have centred around the range and magnitude of the country's socio-economic problems, its vexing production decline and its unsatisfactory macroeconomic performance, which give rise to the following questions: what are the sources of this recent downfall? And can this situation be reversed by pursuing the same orthodox and neoliberal policies?

This new edited volume, from a top international set of contributors, seeks to answer these questions and to offer alternative, realistic and feasible strategies and policy recommendations towards reversing this situation.

In particular, the volume seeks to challenge US neoliberalism on theoretical and political grounds, and to offer alternative strategies and policies towards addressing the country's recent challenges and multi-dimensional problems. The volume is structured around three main themes:

• The return of government: Philosophical issues and ethics

• Economic policies for sustainable growth and prosperity

• Financial fragility and alternative monetary policy proposals

This unique and highly topical, multidisciplinary volume, will be of great interest to students and researchers in the areas of economics, political economy and contemporary US politics.

Part I

The Return of Government

Philosophical Issues and Ethics

1

Why is Neoliberalism Dangerous?

Criticism, Alternative Perspectives, and Government Policy Implications

Zagros Madjd-Sadjadi and Nikolaos Karagiannis

Introduction

Since the 1970s, there has been a steady retreat of the state from the “commanding heights” of the economy around the world. During the Bretton Woods era, Keynesian economic policies reigned supreme, and state guidance of the economy, ranging from outright ownership of heavy industries in the socialist countries of Europe to the more light-handed government regulation found in the United States, was the dominant philosophy. Economists firmly believed that they could end the excesses of the boom–bust business cycle by controlling interests rates and using government regulation. Yet trouble was brewing. As early as 1960, Robert Triffin, a Yale economist, argued in testimony before Congress that since the dollar was the reserve currency under the Bretton Woods agreement, persistent US balance-of-payments deficits were necessary to provide liquidity for the world, but continuing these deficits would undermine confidence in the US dollar and thus lead to the collapse of the fixed exchange rate system. President Johnson’s decision to fight the war in Vietnam and the war on poverty while incurring persistent budgetary deficits only made things worse, and the system quickly deteriorated in the late 1960s with deviations between the official $35/ounce peg and the unofficial price of gold in private markets. The British were the first to feel the sting of this split when they devalued the pound sterling on October 18, 1967 (de Vries, 1976). In 1971, even the mighty US dollar was teetering on the brink of collapse. In response, President Nixon unilaterally closed the gold window, and though the major countries attempted to manage the values of their currencies against the price of gold for the next two years, by 1973, in the wake of the first oil crisis, it was clear that the fixed exchange rate system’s time had come and gone.

Or had it? How could a currency regime based on fixed exchange rates be undermined by one nation? Perhaps the solution would be a multicurrency basket approach and the obvious candidate for such a regime is the Special Drawing Rights (SDRs) of the International Monetary Fund (IMF ) (Zhou, 2009). It had originally been created in 1969 when it became clear that the twin supply of US dollars and gold was insufficient for the demands of an increasingly globalized economic system. The closing of the gold window and the enactment of the Smithsonian Agreement, which was a negotiated depreciation of the US dollar against other currencies, called into question the continued viability of having the US dollar stand as the world’s reserve currency (Bromley, 1991). The Committee of 20 began to look into using SDRs as an alternative reserve but this concept was shelved with the 1973 oil crisis (Toye and Toye, 2005).

The 1973 oil crisis once again instituted the Triffin Paradox but this time in a different incarnation. Since oil is priced in dollars, there would be a persistent “petrodollar deficit” from oil-importing countries to oil-exporting countries. These dollars would then have to be recycled since the accumulation of such dollars as reserves would serve little purpose. The United States thus once again was able to maintain and expand its balance-of-payments deficit, this time using its fiat currency since it was the sole producer of dollars (Engdahl, 1993). The persistent deficits since then have only accumulated, and the final straw of the budget deficit run-up in the Great Recession has demonstrated that confidence in the United States is not infinite. Still, we have not (yet) seen a collapse of the current system, most likely because so many other countries are in even worse shape.

The currency markets had “won” over state intervention in the exchange rate system and the current wisdom was now a movement towards realizing this victory. “Neoliberalism” arose as an answer for how governments should act in the face of the market power that had been demonstrated. Yet, the neoliberal agenda, far from being one that worships free markets, is one that has replaced the rule of governments with the rule of transnational corporations. By retreating from government intervention in the domestic and international economies and glorifying property rights and the rights of corporations to act as “persons” in the economic sphere, neoliberalism has ceded political power to those who have economic power: “Economic control is not merely control of a sector of human life which can be separated from the rest; it is the control of the means for all our ends” (Hayek, 1944, 95).

Starting with Margaret Thatcher in the United Kingdom and Ronald Reagan in the United States, the minimalist state entered the political lexicon. Domestically, it consisted of “supply-side policies”, such as massive reductions in marginal tax rates, in order to spur growth. Internationally, it meant the negotiation of free trade agreements and subsequent rounds of multilateral tariff and trade reductions as well as harmonization of policies across countries, such as copyright and patent protection. New Zealand, Australia, and Canada also adopted similar policies, as did much of Western Europe. The collapse of communism in the Eastern Bloc was seen as further “proof” of the inherent superiority of this approach. Yet the results were not the stellar increases in personal incomes that we might have expected from such wholesale changes for the whole of society if the neoliberal philosophy was the correct one to follow. Instead, such liberalization typically meant increased income inequality and stagnation of worker wages. During the Bretton Woods era from 1946 to 1973, a period of 27 years, real GDP per capita in the United States increased by 83 percent. However, from 1973 to 2010, a period of 37 years that encompasses the time of neoliberalism, real GDP per capita in the United States has only increased by 81 percent (Johnston and Williamson, 2011). From 1947 to 1973, average real hourly compensation rose by 109 percent but from 1973 to 2011, it rose by only 43 percent (Federal Reserve Bank of St. Louis, 2012). At the same time, income inequality in any of its various measurements, which had declined from 1946 to 1973, has risen sharply since then (US Census Bureau, various years).

Key Conceptual Notions

Neoliberalism gained momentum in the 1980s and became distinct and recognizable as an ideology by the 1990s as the “Washington Consensus” (Williamson, 1990). According to Mahmud (2011, 663), “[n]eoliberalism seeks unbridled accumulation of capital through a rollback of the state, and limits its functions to minimal security and maintenance of law, fiscal and monetary discipline, flexible labor markets, and liberalization of trade and capital flows”. Another similar definition states that its basic features include the expansion and liberalization of markets, deregulation, privatization, reduction in government expenditure and marginal tax rates, and “a general belief in the benefits of ‘self-regulating’ free markets to deliver growth and prosperity” (Casey, 2011, 6). Neoliberalism stands in contrast to classical liberalism in that it views the market as a goal in itself as opposed to being something that is a means to the goal of higher standards of living. In this way, it decouples political liberalism from economic liberalism and rather than promoting individual liberty à la libertarianism, it promotes commoditization of everything and the needs of transnational corporations over individuals. A typical neoliberal response is that, as Mitt Romney said on August 11, 2011 during his presidential campaign, “corporations are people”, but this is a naive argument based solely on the notion that since corporations are owned by people and those people benefit, attacks on corporations are attacks on the beneficiaries of these entities. The reality is somewhat nuanced. Corporations represent the pooling of economic and social power that manifests itself in the political sphere as well (Citizens United v. Federal Election Commission, 558 U.S. 08–205 [2010]). As such, corporations exert an influence far greater than that of ordinary individuals and their indefinite life, limited liability, and lack of national citizenship give them additional advantages that individuals lack.

Neoliberalism is actually closer to corporatism than any other philosophy in that, in its abandonment of the traditional regulatory function of the state and embracing of corporate goals and objectives, it cedes sovereignty over how its economy and society are organized to a global cabal of corporate elites (Chomsky, 1998). Within economics, the Chicago School of Economics is the most closely tied to neoliberalism. Starting with the “Chicago Boys”, a Chilean group of Chicago-trained economists who engineered the “Chilean miracle” under Pinochet’s repressive regime, the influence of University of Chicago only grew. By the late 1970s and early 1980s, governments around the world were in retreat from market intervention, and deregulation and privatization were the order of the day. Other policy innovations include welfare and other entitlement reforms, a rollback of civil service protections, and an opening up of traditional government operations to competition from the free market. However, as will be seen in the next section, its conception of how markets work is often divorced from reality. An emphasis on rational expectations and the efficient market hypothesis belies the assumption that the neoclassical economic analysis that undergirds neoliberalism is “value-free”.

Neoliberal Arguments, Policy Suggestions, and Criticism

Neoliberal theorists would suggest that their theories are universal in nature and that assumptions that underpin them are unimportant. The test is whether the theory can predict accurately. This can only be true when the assumptions truly do not matter because they are compatible with all possible institutional matrices. The fact that the assumptions do matter and that neoclassical economists cannot predict using their theory is borne out by one of their central tenets: they assume that the future is inherently unpredictable due to the so-called random walk hypothesis which has as its core principle the assumption that markets are efficient. But this is demonstrably false (Lo and MacKinlay, 1999; Shiller, 2000; Shleifer, 2000) and the recent excessive run-up in housing was not only sadly quite predictable but also quite predicted (Case and Shiller, 2003). Similarly, it is only to be seen whether the current commodity (especially gold) bubble will spark reconsideration of the myth that predictions cannot be made.

First, as to whether efficiency should even be the criterion under which all economic judgments are made must be questioned. It is perfectly efficient and Pareto optimal for Bill Gates (for example) to have everything and the rest of the world to have nothing. However, even neoclassicals would likely find something wrong with this scenario. After all, given that everything, including money, in the neoclassical framework exhibits declining marginal utility, a redistribution of wealth away from the wealthiest individuals may raise overall happiness by making the rich only slightly less happy but making the poor far happier. Who is to say that such redistribution is not better for all? Well, one group that will likely object are those whom the redistribution will make less well-off, and that is precisely the group that stands to benefit from policies such as “socializing losses” and “privatizing gains”.

Nor are markets naturally efficient. The tendency of firms to grow ever larger and to come to hold market power reduces the natural inclination of competition to lower prices. Market processes involve transaction costs and these transaction costs can be rather hefty when compared with non-market transactions (Coase, 1937). Indeed, the only efficiency that seems to matter to neoclassical economists is what is known as allocative efficiency, a type of efficiency that barely registers in terms of increases in overall financial well-being. It is difficult to ascertain what benefit the United States has derived from its numerous free trade agreements; a situation made even more difficult since each of them is really a treaty that discusses how the United States shall deviate from free trade as opposed to promote it (Karagiannis and Madjd-Sadjadi, 2007). Instead, in the area of X-inefficiency (Leibenstein, 1966), where most of the gains are to be measured, nothing that is found in the neoliberal agenda will serve to improve it.

The next assumption of self-equilibration of markets is also highly problematic. While markets tend toward an equilibrium state in the long run, they decidedly do not in the short run. Unfortunately, the short run can last for a very long time. Equilibrium is, by definition, a state of rest from which no movement is possible without exogenous shock. But since markets are constantly in motion, the idea that there is ever an equilibrium position of rest is clearly not plausible. In addition, the mechanism by which markets move toward “equilibrium” is not through a Walrasian auctioneer nor an invisible hand, but rather through messy processes involving arbitragers who seek to squeeze profits out of small differences between markets in time or space. These processes are artificial rather than natural and, as a result, are themselves subject to imperfections that lead them to “overshoot” the ideal position. Volatility should be reduced as time goes on if these activities were leading toward a superior determination of equilibrium. Instead, volatility has been increasing. When this volatility is not matched by increases in liquidity a “flash crash” resulting from “order toxicity”, causing market makers to exit the market en masse, such as happened on May 6, 2010, can ensue (Easley et al., 2011). Indeed, neoliberal policy often follows a procyclical rather than counter-cyclical path, with politicians making the case for increased austerity during economic downturns while ignoring budget deficits during periods of economic growth. This is a good way to move the economy away from equilibrium in both realms and increases the probability of asset bubbles, which are fundamentally something that should never occur in a self-equilibrating system.

Furthermore, it is not a cogent argument as it fails the falsifiability test. We can only reject a theory that states A implies B if we show that A exists but B does not, according to Aristotelian logic. Time and again, neoclassical economists and their neoliberal brethren have failed to accurately predict the future. If their claims are to have any validity then their theories must be robust enough to have predictive power. Neoclassical economists argue against alternative conceptions by insisting that only a theory that makes better predictions should be able to supplant an existing one. This is also arguing from an illogical basis. All we can show is that the variables have a high or low covariance. Even if we find a theory with perfect predictive power, we can say nothing about cause and effect.

It is just as appealing to state that thunder causes lightning as stating that lightning causes thunder. They are linked but neither creates the other; they are created by a third force. However, this fallacy is even more insipid. Let us suppose that we know that one variable creates the other and we are simply trying to determine which creates the other. Therefore, we assume that A creates B because we first observe A. Unfortunately, this doesn’t work. Observation is based on the relative position of the observer and the distance between the observer and the object in question. If I use a sound amplification device to destroy a wall, you might see the wall being destroyed prior to the sound reaching you and conclude (erroneously) that the destruction of the wall created the sound. We do not know which variables are picked up faster than others so caused and effect cannot be ascribed even if we know that one creates the other. What does this have to do with economics? If our ability to measure a variable improves over time so that we come closer and closer to the actual occurrence of the event, we may begin to observe B before A. Now we have the classic chicken-and-egg problem. Nor can we simply ascertain that we erred in the first case because the basis for judging the other variable may not have changed.

Notice that the problem will be aggrav...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright
• Contents
• List of figures
• List of tables
• Notes on contributors
• Foreword
• Alternatives to US neoliberalism: an introduction
• Part I: The return of government: philosophical issues and ethics
• Part II: Economic policies for sustainable growth and prosperity
• Part III: Financial fragility and alternative monetary policy proposals
• Index