The Emergence Of Neoliberal Development Theory Economics Essay

This essay aims to justify the emergence of neoliberal development theory by analysing the historical, political and economic backgrounds in the second half of the twentieth century and identify the key features of its success. Also, the essay aims to establish the reasons behind the failure of the Keynesian model that was dominant prior to the neoliberal theory. Firstly, it will define ‘development’, outline its origins and goals and look back at the history of development to identify major theories prevailing in the global economics. Secondly, it will account for the transition from the Keynesianism to neoliberal theory and argue that the main drawback of the former – extensive state intervention in economics – was the reason behind the rise of the latter. Finally, it will analyse the neoliberal development theory in terms of its strengths and weaknesses and conclude with suggesting perspectives of the theory in the future.

What is development?

Development presents an elusive concept to define. As the term itself is incredibly broad, the simplest definition of ‘Good Change’ (Chambers 1997) will not suffice: factors such as time, perspective and focus should be considered to encompass the term (Thomas 2000). Development does not happen overnight, therefore, to understand it we need to look at a series of changes throughout history and the inevitable processes which accompany it. Secondly, understanding of development shifts depending on the vision or perspective of what development aims to achieve (modern society, maximum use of human potential or fixing the faults of progress). Finally, development could be seen as a focused effort to eradicate a problem (i.e. poverty, hunger, AIDS, etc.).

Generally, development is summarised as a process of developing countries trying to catch up with developed countries (Kiely 2007). If we look at the current goals in development outlined by the Organisation for Economic Cooperation and Development (OECD), we can see that in developing countries by 2015:

Extreme poverty should be reduced by one half.

Universal primary education should be ensured and gender disparity in education eliminated.

Infant/child mortality should be reduced by two thirds and maternal mortality – by three quarters.

National strategies for sustainable development should be implemented (OECD 1996).

On the surface these goals appear to tackle social problems (quality of life and education) but they are deeply intertwined with both politics and economics. In order to achieve those state leaders need to work along with international organisations whose economic expertise can help to shape needed policies. No matter how noble these aspirations sound, it is the question whether they are realistic enough to implement that we should ask ourselves. It is possible to access the chances of success better by looking back at the history of development and its former achievements.

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The modern history of development begins with the end of the Second World War in 1945 when new states emerged and the old international order was reshaped. The key theme in development was expanding the economic growth through industrialisation. The unique position of the USA after the war (minimal losses) facilitated its becoming a super power. Not only did it have an exceptional political influence in the international affairs but it also helped to promote capitalism and democratic values in Europe as well as the developing countries. The USA did this not only through foreign aid and direct investment but creating such international organisations as the UN, the IMF and the World Bank.

The Cold War split the world into two camps: capitalist and communist. While the superpowers were trying to win more political influence, they also helped to modernise developing countries by boosting their economies. Of course, it came with a price – joining a camp of the donors. The USA supported national liberation of the colonies and promoted development of anti-communist ex-colonies. This period from 1950s to 1970s is also known as the ‘golden age’ of capitalism. High rates of profit facilitated high rates of capital accumulation and unprecedented economic growth, high productivity, high wages, expanding demand (Kiely 2007). Such growth resulted in full employment, creation of welfare system and a spread of globalisation.

However, by 1970s the problems with the system became obvious: states had monopolized important industries (coal, steel) which limited the capacity of economic growth, thus investment was dominated by political not economic reasons. Preston argues that there was an assumption that states have the right to intervene directly in production and distribution (Preston 1996: p. 154-156). This resulted in capital not being allowed to cross borders without government approval, so states could set domestic interest rates, fix the exchange rate, tax and spend as they wanted to secure national economic objectives, moreover, the divide between developed and developing countries remained high (Leys 1996). The decline in profit rates recorded in the centre countries at the end of the 1960s deepened and in the 1970s spread into an open capitalist crisis, characterized by a swing of the whole system into monetary-financial chaos, exploding inequalities, and mass unemployment (Herrera 2006).

The Keynesian model

The ‘golden age’ of capitalism was dominated by the Keynesian development model, which maintains that the level of economic activity is determined by the level of aggregate demand (Palley 2004). John Maynard Keynes, the forefather of modern macroeconomics, advocated an interventionist form of government policy believing markets left to their own measure (i.e. completely “freed”) could be destructive leading to cycles of recessions, depressions and booms. To mitigate against the worst effects of these cycles, he supported the idea that governments could use various fiscal and monetary measures. His ideas helped rebuild after World War II, until the 1970s when his ideas were abandoned for freer market systems.

Within this theory the unemployment could be explained through weakness in the aggregate demand generation process that capitalist economies are subject to. In order to avoid recession governments ought to implement monetary and fiscal policy to stabilise the demand generation process.

The postwar Keynesian model both smoothed the business cycle and protected vulnerable workers through the extension of the welfare state, allowing them to become stable mass consumers. The problem for this model is that it faced an inherent “spending ratchet” – it was easy for governments to spread the fiscal goodies during the downturns, much harder to take them away in the booms (as Keynes advocated) – creating inflationary pressures and undermining growth in the 1970s.

With regard to income distribution, Keynesians have always been divided, and this created a fatal breach that facilitated the triumph of neoliberalism. American Keynesians (known as neo-Keynesians) tend to accept the neoliberal “paid what you are worth” theory of income distribution, while European Keynesians (widely associated with Cambridge, U.K., and known as post-Keynesians) reject it. Instead, post-Keynesians argue that income distribution depends significantly on institutional factors. Thus, not only do a factor’s relative scarcity and productivity matter, but so too does its bargaining power, which is impacted by institutional arrangements. This explains the significance of trade unions, laws governing minimum wages, employee rights at work, and systems of social protection such as unemployment insurance. Finally, public understandings of the economy also matter, since a public that views the economy through a bargaining power lens will have greater political sympathies for trade unions and institutions of social protection (Palley 2004).

However, in the mid-1970s the Keynesian impulse went into reverse, to be replaced by neoliberalism. This reversal piggybacked on the social and economic dislocations associated with the Vietnam War era and the OPEC oil price shocks, which dominated the 1970s. However, these dislocations only provided an entry point. The ultimate spark of neoliberal dynamism is to be found in the intellectual divisions of Keynesianism and its failure to develop public understandings of the economy that could compete with the neoliberal rhetoric of “free markets.” (Palley 2004)

At the cultural level, America has always celebrated radical individualism, as epitomized in the frontiersman image. This radical individualism was further promoted by the ideological conflict embedded in the Cold War, which fostered antipathy to notions of collective economic action and denial of the limitations of market capitalism.In particular, collective economic action was tarred by identification with the communist approach to economic management. The Cold War, therefore, provided fertile ground for popularizing an economic rhetoric that spoke of “natural” free markets independent of governments and in which government regulation reduces well-being (Palley 2004).

What is neoliberal development theory?

Neoliberalism is in the first instance a theory of political economic practices that proposes that human well being can best be advanced by liberating individual entrepreneurial freedoms and skills within an institutional framework characterized by strong property rights, free markets and free trade. The role of the state is to create and preserve an institutional framework appropriate to such practices (Harvey, 2005: 2).

Integral to these changes has been a shift away from Keynesian economic ideas, which emphasized the political management of aggregate demand, to a more conservative discourse based on monetarist, supply-side, and rational expectations theories (Heilbroner and Milberg 1995).

Neoliberal development theory has emerged in 1970s with the end of the ‘golden age’ of capitalism. As the world economy was entering a recession, old strategies ceased to work and neoliberalism claimed to overcome the crisis. The core of the theory lied in an assumption that bad policies were rooted in extensive governmental intervention in economics. Economic growth could be restored by policies ensuring competitiveness in the world economy. Neoliberal development theory aimed to enhance growth, create free markets, replace the Keynesianism that proved to be weak, and eliminate the intervention of the state in the economy that resulted in poor economic performance in many countries (Harrison, 2005). This approach was adopted by major international organisations such as the IMF and the World Bank which made the transition faster.

The manner in which the Communist states of the Soviet Union and Eastern Europe collapsed under the weight of popular discontent and poor economic performance in the 1980s also gave considerable sway to arguments that free market. capitalism had proven to be a superior political-economic system to those that had been its alternatives (Flew 2012).

At the national level, it is a question of carrying out an aggressive anti-state strategy by: (1) deforming the structure of capital ownership to the benefit of the private sector, (2) reducing public spending for social purposes, and (3) imposing wage austerity as a key priority in fighting inflation. At the global level, the objectives are to perpetuate the supremacy of the U.S. dollar over the international monetary system, and to promote free trade by dismantling protectionism and liberalizing capital transfers. The standardization of this planetary deregulation strategy is one of the functions of the major international organizations (primarily the International Monetary Fund [IMF], the World Bank, and World Trade Organization [WTO]), and the local monetary-financial institutions (“independent” central banks). The entire edifice is thus brought under the control of the United States, whose military supremacy guarantees the global functioning of the system (Herrera 2006).

Structural Adjustment

Originally, the neoliberal economic model followed the “Washington Consensus” on development policy and was adopted by the International Monetary Fund (IMF), the World Bank, and many important U.S. agencies. Named after its association with international financial organizations located in the U.S. capitol, the Consensus always included fiscal discipline, taking steps against inflation, opening up economies to foreign trade and investment, reducing the role of the government in general, and promoting new exports (Skidmore and Smith, 2005: 59). As complementary to these goals, the Consensus also advocated tax reform including cutting marginal tax rates (reducing taxes for the rich), creating a unified and competitive exchange rate, and securing property rights (particularly for foreigners in developing countries) (Todaro and Smith, 2006: 538). Any country that implemented all of these goals into their development strategy, was taking on neoliberal development in its most orthodox form. However, this orthodox policy made no mention of reducing inequality or the need to eliminate absolute poverty as a meaningful way to achieve development (Todaro and Smith, 2006: 548). – THESIS LUBLINER

Neoliberal theory holds that a market-led economy is necessarily better than a government-led economy in terms of development in general and poverty alleviation in particular, but the concept is both incomplete and partially flawed. The concept rides on the relatively simple notion of efficiency. Neoliberal theory holds that markets can more efficiently distribute capital, goods, and services, throughout the world than governments can. The driving force behind this is competition. Due to this competition, corporations search the world for cheap, efficient labor, offering employment to those people who would otherwise be worse off economically. They also provide potential for countries to raise the output of their exports, thereby allowing for an increase in gross domestic product (GDP)7. For these reasons, proponents of neoliberal reform recommend reducing barriers to foreign investment, especially foreign direct investment (FDI). This can be achieved by liberalizing the financial system of a government through the reduction of taxation on foreign companies, among other means. _THESIS LUBLINER

a striking feature of capitalist states globally during the last three decades is the proliferation of neoliberal policies of deregulation, privatisation and marketisation (Cahill 2010).

The conceptual starting point for neoliberal theory is the rational, self-interested individual with unique and subjective preferences. From this is constructed both a philosophical and an economic defence of free markets. The philosophical defence begins by positing liberty, understood negatively as freedom from coercion, as the primary goal of society. Markets are understood as spheres of voluntary exchanges between individuals. Since no rational individual would voluntarily enter into a disadvantageous exchange, markets enable both parties to satisfy their preferences free from external interference or coercion. Thus free markets are the best means of providing the conditions under which individual liberty can flourish. The economic defence of free markets holds that markets, as spheres of voluntary exchange, enable for the preferences of rational self interested utility maximisers to be expressed and satisfied. Under perfectly free conditions and in the presence of a multitude of buyers and sellers, prices act as information signals about the preferences of individual agents, ensuring that resources are allocated upon the basis of such preferences. Thus, neoliberals argue that markets, when freed from external ‘interferences’, most notably in the form of the state, are the most moral and the most efficient means for producing and distributing goods and services. (Cahill 2010).

Government regulation of markets creates ‘distortions’, thus creating inefficiencies, and the political considerations involved in formulating such regulations means that governments are, in effect, ‘picking winners’ by favouring certain industries rather than allowing markets to produce optimal outcomes. Furthermore, such regulations inevitably infringe individual liberty. Neoliberals thus advocate a radical dismantling of the state: the transfer of the provision of goods and services from the public to the private sector (Cahill 2010).

Strengths/weaknesses

the international organizations call on national governments to adopt neoliberal economic policies imposed from without while the globalized financial markets dispossess these states of their sovereignty and foreign core capital insinuates itself into the periphery countries’ capitalist ownership structure (Herrera 2006).

Numerous studies suggest that there has not been a general decline in the size of the state during the neoliberal era. Tanzi and Schuknecht (2000: 6-7) found that between 1980 and 1996, total government expenditure as a proportion of GDP in the 17 major industrial capitalist economies grew from 43.1percent to 45.6percent. Rodrik’s study of OECD and non-OECD countries posits a ‘positive correlation between an economy’s exposure to international trade and the size of its government’ in the years from the 1960s to the 1990s (Rodrik 1998). While Garrett (2001: 27) modifies this view somewhat by pointing out that ‘whereas levels of trade and levels of government expenditure are positively correlated, countries in which trade has increased more quickly in recent decades have experienced slower growth in government spending’, such evidence still points to an expansion of the absolute and relative economic size of government during the neoliberal era (Cahill 2010).

Future Perspectives