In the shadow of the Keynesian revolution that replaced the neo-classical, laissez-faire approach to capitalism after WWII, a political and economic fringe was picking up momentum in the US. The aforementioned Austrian school economist, Ludwig von Mises, who was enamoured by the heroic individualism in American cowboy TV shows, and a disgruntled Russian refugee, Ayn Rand, were slowly gathering followers. Home-grown ‘right-libertarianism’, and its most prominent figure, Milton Friedman (1912–2006), were also learning the ropes. All this was further fuelled by the perceived threat of the Soviet Union (a sentiment that often reached paranoid proportions in the US), and kept alive by generous financial support from big business. So-called neo-liberalism was slowly taking shape. By the 1970s, Friedman and his ‘Chicago School’ economists had developed ultra ‘free-market’ ideas based on deregulation and privatisation that harked back to the laissez-faire capitalism of the 19th century (hence the term ‘neo-liberalism’). In a nutshell, rather than the state raising and spending money to stimulate the economy (which was the Keynesian approach), neo-liberals advocated giving money to the rich (through tax-cuts and stimulus packages) with the justification that they would then spend and invest more, and thus stimulate the economy. Such newly created wealth is supposed to trickle down to the rest of the population by creating new jobs and income (this is known as the ‘trickle-down’ theory).
Volumes have already been written highlighting the extent to which Friedman’s ‘philosophy’ is incoherent and removed from reality. But perhaps there is a good reason why going into depth about it is not even necessary: Friedman’s starting premise is that human beings always act in their self-interest. If this is true, then paraphrasing a classic example of deductive reasoning, it follows that:
Friedman is a human being,
Human beings act in their self-interest,
Friedman acts in his self-interest.
So, Friedman’s own premise, if applied to him, brings into question his commitment to objectivity as a scholar, and the impartiality of his conclusions. It might be argued that in such cases, acting in one’s best interest requires being objective (in order to maintain a good academic reputation). This, however, only reveals how deeply problematic this position is. If everybody (including academics) acts only in their self-interest, claims of objectivity and a search for principles that can have shared, universal value become just window-dressing – a trick used to advance one’s own self-interest. Friedman’s biography shows that this is not just a trivial wordplay. He was, indeed, faithful to serving his own self-interests (or perhaps his philosophy was a justification for the propensity of his character to always put his self-interests first). Before he was earning plaudits as an economic guru, he was a shill for the real estate industry and an early pioneer of big business propaganda known as libertarianism. Back in 1950, the House of Representatives held hearings on illegal lobbying activities and exposed both Friedman and the earliest libertarian think-tank outfit, the Foundation for Economic Education (FEE), as a front for business lobbyists. They discovered that the ‘Foundation’ was, in fact, a big-business PR project backed by the largest corporations and lobbying fronts in the country. Its donors included the big three car makers, GM, Chrysler and Ford; leading oil companies including Gulf Oil, Standard Oil, and Sun Oil; major steel producers US Steel, National Steel and Republic Steel; large retailers, including Montgomery Ward, Marshall Field and Sears; chemical giants Monsanto and DuPont; and other Fortune 500 corporations, including General Electric, Merrill Lynch, Eli Lilly, BF Goodrich, and ConEd. In short, right-libertarianism in America started as an arm of big-business lobbying – a project launched in 1946 by the US Chamber of Commerce and the National Association of Manufacturers. The purpose of the FEE — and libertarianism, as it was originally created — was to supplement big-business lobbying with an intellectual, economic rationale to back up its policy and legislative attacks on labour and government regulations. In other words, libertarianism was little more than an ideology that aimed to promote a corporate agenda – and Friedman was very much a part of it.
All the theories and ideas that were influenced by the Cold War paranoia, such as the game theory work of John Nash (of A Beautiful Mind fame), the rantings of Ayn Rand, or Isaiah Berlin’s distinction between negative and positive freedom, were used to advance the neo-liberal agenda. Even the very principles they relied on were bent if necessary. For example, the concept of imperfect competition was stretched to the limit to allow for private monopolies while still maintaining the claim that the ‘invisible hand’ works. In fact, the very name ‘libertarianism’ is a misnomer: it actually meant restraining the freedom that was increasing as the result of democratic processes. As Friedrich Hayek remarked on a visit to Pinochet’s dictatorship in Chile – the first nation in which the neo-liberal economic programme was comprehensively applied – “my personal preference leans toward a liberal dictatorship rather than toward a democratic government devoid of liberalism”. The disciples of the Chicago school actively helped Pinochet, and Friedman himself visited Chile and befriended and praised the dictator; later, despite all the rhetoric of fighting for the ‘free world’, Thatcher and Reagan also counted Pinochet as their close and dear friend.
Chile was just an experiment, though; these guys had bigger plans. The crisis in the 1970s was what the neo-liberals were waiting for. This was a chance for a counter-revolution plotted in the shadows of economic and business institutions for decades. Hayek, who had lived in relative obscurity in West Germany, was brought into the limelight and in 1974 won the Nobel Prize for Economics (which came as a surprise even to him). Two years later, Friedman was also awarded the Nobel Prize and became the most prominent scholar of economics in the West. The apologists for big business became the mainstream economists. With Thatcher and Reagan coming to power, the new ideology could be applied on a much more significant scale.
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Putting theory to practice
Broadly speaking, neo-liberal intervention involved the removal of price controls, the sale of state companies, the removal of import barriers, cuts to government expenditure, a strong military presence abroad and police presence at home, and advocating (sometimes forcefully) market liberalisation globally, while often maintaining covert protectionism at home. What about reducing taxes? Well, Reagan actually decreased only the taxes of the rich, and actually increased the taxation of ordinary working people. As renowned investor George Soros remarked, “the burden of taxation has only shifted from capital to citizens”.
The rich could now become very powerful again, and they took this opportunity with a vengeance. In the early 1980s, the full political resources of corporate America mobilised to regain control of the political agenda and the court system. Thatcher and Reagan, using the Chicago School ideas, effectively dismantled the social contract and made the world friendly for the corporate and financial sectors. This involved several moves:
- ‘Turning the Bull[1] loose’: the Bull was unleashed by a massive reduction in regulations, which allowed the financial sector to get out of control. An oft-used comparison with cancer doesn’t seem far-fetched in this case: deregulation led to an overgrowth of part of the system at the expense of the rest.
- ‘Starving the Beast’[2]: a political strategy to deprive the government of revenue (by cutting taxes, for example) in order to reduce state power and justify rolling back social welfare.
- Dismantling the power of unions in the UK and turning the public against them in the US (even Hollywood stars, such as Sylvester Stallone, were enlisted to appear in movies that aimed to discredit unions).
- In terms of fiscal policy, the only concern was inflation (which again benefited the rich more than the poor). But, whenever one economic objective is targeted exclusively, problems invariably arise in other spheres of social, economic or political life, such as an increase in unemployment, which was wilfully ignored.
- Stepping up privatisation – many public services, utilities and parts of the infrastructure were sold off for a dime, including natural monopolies (e.g. sewage systems or rail tracks) – even though the usual justification for privatisation, namely that it improves quality because of competition, does not apply to them.
While all this contributed to the flourishing of the financial and corporate sectors (leading to mega-corporations and monopolies), it had largely negative effects on small producers and the real economy in general. For example, the 1980s witnessed an explosion in corporate raids, ‘hostile takeovers’ and asset stripping that saw production lines closed down and workers laid off – anything that did not make quick money was discarded, irrespective of other considerations. Nevertheless, the neo-liberal agenda was to become the economic orthodoxy of globalisation. A massive increase in interest rates in the US and the UK (brought about in order to control inflation) triggered the debt crisis of 1982. This gave the US the opportunity to strengthen its dominant role in the world economy as well as the World Bank and the International Monetary Fund (IMF). These institutions had become by then a far cry from their original purpose and spread neo-liberal ideas globally by imposing ‘structural adjustments’ on developing countries. This is why neo-liberalism is also known as the Washington Consensus, referring to the fact that it is advocated by the three most powerful economic organisations in the world, all headquartered in Washington, DC: the US Treasury, the IMF and the World Bank Group.
Of course, this transition was not simple. The closest implementation of Friedman’s model in the West was monetarism in the first few years of Reagan’s presidency. The result was so dismal that it had to be reversed after only a couple of years. In the UK, unemployment increased from around 1 million during the (second) crisis in the 1970s to 3.3 million after a few years of Thatcher’s reign. In fact, the economic situation was so bad that she was apparently close to resigning. So, how did she manage to pull through it? Why did people put up with the situation? Thatcher was voted in another two times and was only ousted by rebels in her own party. Reagan served the maximum two terms and his vice-president took the mantle afterwards. Well, several factors and some luck contributed to changes of fortune for them: in the UK, new oil discoveries and extraction in the North Sea brought badly needed revenue to the government and helped to deal with the energy crisis, while winning the Falklands War (1982) re-ignited patriotism and increased Thatcher’s popularity. Across the pond, Reagan’s survival after an assassination attempt (1981) enhanced his popularity and made Democrats (who controlled the House of Representatives at that time) reluctant to vote against his policies. Most of all, the fall of the Berlin Wall (1989) and the spectacular collapse of the Soviet Union (1991) helped to create a sense of triumphalism. The left-wing parties in the West were in disarray. Although the industrial parts of the US (the ‘rust belt’) as well as the north of England and the mining communities of South Wales were in deep decline, a new breed of city-folks, excited about opportunities that deregulation and privatisation offered, balanced the voting books. Add to this mix a massive propaganda machine and the boom of new technologies (IT in particular) that brought a desperately needed economic boost, and you get the circumstances that lead to wilful blindness. Thatcher famously proclaimed that ‘there is no alternative’ (TINA) and some, such as the political scientist Francis Fukuyama, went so far as to declare the ‘end of history’.
This is not to say that everybody embraced neo-liberalism. Notably, in Western Europe, many countries maintained their allegiance to social democracy and the so-called mixed economy. It was clear from early experiments with the neo-liberal model, such as Pinochet’s Chile, that neo-liberalism was compatible with authoritarian and even dictatorial regimes, but much less with, and hard to sell to, social democracies. However, fledgling democracies emerging from the wreckage of the Soviet Union were a good target. A ‘shock doctrine’ was tried in Russia itself, with disastrous consequences except for a few newly created oligarchs: it is estimated that more than a million people died prematurely and unnecessarily in that period. President Yeltsin was supported by the US in shelling his own parliament in order to push through the reforms. The need to reverse this trend paved the way later for an authoritarian leader, Vladimir Putin, who still rules Russia. China voluntarily but very selectively applied some elements of the neo-liberal model in order to be able to export to the West. But, as already mentioned, many other, especially small and developing, countries were forced to implement the major tenets of this doctrine. The counter-revolution was, for all practical purposes, complete.
When traditionally left-leaning parties or heads of states came to power, notably Bill Clinton in the US and Tony Blair in the UK, nothing changed. Blair has been clear about his intentions: “I always thought my job was to build on some of the things [Margaret Thatcher] had done rather than reverse them”. They both continued in the same direction as they too came to believe in TINA. Even if they did not, the state and politicians were by then already too weak to do anything. The Bull, once released, could not be corralled in again. It took only a couple of hours to bring the truth home to a newly elected President Clinton and persuade him to abandon social programmes that were the platform of his electoral campaign. The persuader was no less than Alan Greenspan, the Chairman of the Federal Reserve at that time, and previously a member of the Ayn Rand inner circle.
However, the ride was far from smooth from the beginning. A succession of crises forced the most extreme elements of this doctrine to be watered down, although its main legacy, a more-or-less free reign for the corporate and financial sectors, has been with us in an ever-more destabilising and toxic form since.
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‘Casino economy’
Between 1980 and 2002, the world economy went from one boom and bust to another, like those who stagger from one binge drinking session and the following hangover to the next:
1981–82 ‘Reagan’s recession’, with an inflationary surge and unemployment rising above 10% in the US.
1982–90 Debt crises in Mexico, Brazil, Chile, Argentina and Poland, sparked by the ‘Volcker shock’ of high interest rates; (in effect, US investment bankers being rescued by ‘aid’ to indebted countries organised by the Washington Consensus).
1987 Recession in the UK property market and the Black Monday stock market crash that followed a speculative boom (just months after Greenspan took over at the Fed).
1990 Nordic (in Sweden, Finland and Norway) and Japanese banking crises; bail-outs of some major US banks.
1992 Black Wednesday in the UK, when the UK government was forced to withdraw the pound from the European Exchange Rate Mechanism.
1994–95 A Mexican currency crisis (triggered by high expectations when Mexico embraced free-market policies and signed the North America Free Trade Agreement).
1997 The South-East Asian currency crisis, a result of asset bubbles bursting after countries opened up their financial markets quite radically in the early 1990s. The expectation of ever-rising asset prices fuelled excessive borrowing and lending. In the end, tens of millions of people lost their jobs. In return for a bailout by the US and the IMF, these countries had to accept further ‘free-market’ policies.
1998–2001 Capital flight from the financial crisis in Russia and the overlapping crisis of the Long Term Capital Management (LTCM) hedge fund (Simms, 2013, p.131); also debt crises in Brazil and Argentina.
2001–02 Dot-com bubble and stock market crashes that were dealt with by aggressive cuts in interest rates, which in turn led to a real-estate bubble.
2002–07 About five years of relative calm attributed to the ‘wise men’ running the world economy; in fact, they were calm mostly because of China’s appetite for resources and investment. In this period, Russia and many South American countries abandoned neo-liberal policies that didn’t serve them well.
Defenders of neo-liberalism would say that the accelerated rate of crises was the result of an increased rate of globalisation and the opening up of new markets, but this can be only a partial explanation at best. It is symptomatic that almost all, if not all, these crises were linked to the financial market as a direct result of neo-liberal policies. So, deregulation at a time of rapid globalisation would be closer to an accurate summary.
There was something else that contributed to the frequency of these events: every ‘solution’ created fertile ground for another crisis. This is similar to the following scenario: imagine one day you decide to go to a casino called ‘The Future’. You start winning, but at a certain point you begin to lose money. The manager says to you, “no problem, you can borrow money from The Future to repay your debts and you will have some extra left.” You play with that extra money and eventually lose that too. “Ok”, the manager says, “borrow even more from The Future…” and so on.
Capitalism is only as strong as its latest temporary fix. For example, towards the end of the 20th century, the Asian markets were in a crisis that was threatening to spread to the West. Many countries realised that the neo-liberal philosophy imposed on them was not working for their benefit. It was destroying local economies, depleting them of natural resources and putting them through an endless cycle of borrowing and repayments – effectively making them vassals. Those who could, changed course and started to save money. As a consequence, the US was flooded by ‘cheap money’, which needed to be invested. The IT bubble and the subsequent crisis in the noughties promptly came along.
In order to deal with the consequences of this crisis, the wage–profit contradiction needed to be tackled: if wages rise, firms face greater costs and smaller profits, but if wages fall, firms face more difficulty in finding consumers and see their profits decrease. You may recall that at the beginning of the 20th century, Ford increased wages in order to stimulate consumption. Neo-liberalism made it easier for companies to reduce wages, by cutting trade union power and enabling them to relocate jobs to low-wage economies. The solution? Cheap credit. Make individual borrowing easier, so that firms can make a profit even if they keep wages low! In order to bolster consumption (one leg of capitalism), banks were encouraged to lend easily to the general public (the other leg of capitalism) and the system marched on again. The credit card, which used to be a symbol of affluence and prestige, became available to virtually everybody. With borrowing having never been easier, individual debts exploded while savings diminished. Ironically, this didn’t do much to stimulate manufacturing in the West, as it was inundated by cheap goods from China, which as a result became the world’s second-largest economy. As mortgages were also easily available, people started buying houses for prices beyond their means, or buying second or even third houses as investments. The consequence of this was the 2007–08 housing bubble and the biggest crisis since the Great Depression of the 1930s.
From a ‘Casino economy’ to a ‘Mickey Mouse economy’
Several major factors played a part in the 2008 property-led crisis:
- Excess savings flowing in from Asia, while Americans had low savings rates.
- The relationship between executive compensation and short-term profit goals, which encouraged aggressive mortgage marketing and risky lending.
- The reckless lowering of interest rates by the Federal Reserve Board, which fuelled the housing bubble further.
- The highly leveraged balance sheets of large financial institutions (as a result of the decoupling of money and credit aggregates, banks doubled leverage in a few years before the crisis).
- Loose regulations that allowed for a toxic combination of the above.
The crucial question here is why did financial institutions continue making risky mortgage loans almost until the end? The answer to this question is not simple but is not too complicated either. As mentioned, the ‘solution’ for the previous crisis was easy credit. A property bubble grew on the mountain of debt. This was possible because the mortgage lenders did not hold on to their subprime mortgages (insecure mortgages that were unlikely to be repaid). They sold them to investment banks that packaged them together with more sound mortgages and sold securities (vastly overrated by the rating agencies) against the package to Fannie Mae (The Federal National Mortgage Association), pension funds, insurance companies and banks around the world. The banks and financial institutions were increasingly dealing with subprime mortgages. They created a false sense of security by repackaging them with some safe investment in the hope that the safe part would keep the whole package afloat. But the opposite can happen too: the unsafe part can sink the whole package – which is exactly how it turned out. It was, in effect, not the fault of some individuals or companies – the system just went totally out of control. It was only a matter of time before it all came crashing down. A story goes that the regulators were alerted that something was seriously wrong when they discovered an approved mortgage application signed ‘Mickey Mouse’.
How did the system deal with this crisis? Quite simply, it didn’t. Subsequent economic policy, especially in the Anglo-Saxon world, has relied overwhelmingly on monetary policy, especially quantitative easing, with limited success. The crisis and its consequences are still with us more than a decade later. Resolution Foundation research shows that only the top 1% of households in the UK fully recovered from the financial crisis; the rest of the British population, especially the young and those renting homes, are still struggling. Granted, the system has managed to contain the crisis by slashing interest rates to historical lows (even negative interest rates have been contemplated and, in fact, implemented for some commercial banks’ deposits at the central bank); by bailing out big businesses and financial institutions that are, apparently, ‘too big to fail’; and by introducing so-called austerity measures. In other words, passing the burden of the huge budget deficits created by bailouts onto the general population, through cutting social services and wages (income per capita in the West is still below the 2007 level). The Western economy has been persistently sluggish. Not surprisingly, this period is sometimes called ‘the lost decade’ (Chang, 2014). But is it really that bad?
[1] ‘The Bull’ stands for the financial industry
[2] The ‘Beast’ stands for the government.
