A challenge to economic orthodoxy

The pillars of economic orthodoxy are shaking as the economists at the International Monetary Fund question the merits of neoliberalism. A recent article in the IMF’s quarterly magazine Finance & Development asks simply “Neoliberalism: Oversold?” and concludes that in some cases the answer is “yes.” The reassessment is important, as it shows a readiness among the faithful to question conventional wisdom. At the same time, however, this new analysis is not a repudiation of all neoliberal tenets. A sensible balance, it seems, is the proper response to crisis, not principle divorced from reality.

Neoliberalism is capitalism in its purest form. It calls for the smallest possible government, the opening of domestic markets to foreign competition, and allowing capital to go to where it will (ostensibly) be used most efficiently. In practice, this means shrinking the state and lifting the hand of bureaucracies, privatizing enterprises, balancing budgets, opening domestic markets to international competition and permitting money to move across borders with minimal restrictions.

The poster boy for neoliberal success is Chile, which implemented such reforms under dictator Augusto Pinochet in the early 1970s and enjoyed 5 percent annual growth in per capita real income from 1985 to 1996, which set the pace for Latin America. That success, along with support from Ronald Reagan and Margaret Thatcher, pulled neoliberalism from the fringes of economic discussion into the mainstream.

For decades, neoliberalism has provided the intellectual framework for international financial institutions like the IMF, and has been a core component of “the Washington Consensus.” It guides the lending behavior of those institutions, offering a vision of the idealized economic order that should promote prosperity, growth and stability. This framework was no mere abstraction, however: Neoliberal policies were imposed on borrowers when they turned to the IMF for help in a crisis, as happened in Indonesia in 1998 during the Asian financial crisis and again as Greece struggled through its most recent economic crisis.

Yet, today IMF economists appear no longer convinced of the salutary value of the entire package of neoliberal reforms. While “there is much to cheer in the neoliberal agenda,” the “benefits of some policies that are an important part of the neoliberal agenda appear to have been somewhat overplayed” and “some parts of the neoliberal agenda have not delivered as expected.”

Two policies in particular are problematic. The first is the resort to austerity, or the demand that governments restrain spending (and usually simultaneously increase taxes) in an attempt to balance the books. While budget surpluses are desirable — especially for smaller countries that are at the mercy of international creditors — they are not necessarily good in and of themselves. Most importantly, austerity that demands big cuts in government spending and the gutting of social services, in tandem with the imposition of new taxes, reduces growth, which reinforces a downward economic spiral. Rather, the authors conclude, it is better for debt to “decline organically through growth” than through imposed austerity.

The second problematic policy is the call for unrestricted flows of capital. While international investment can be used to spur development when used for investment, the IMF economists concluded that such flows can also be dangerous as they can and often do lead to financial crises in emerging economies. The chief culprit is the “hot money” that flows in and out of countries’ stock markets and is subject only to the whims of international financiers. Money moves in and out in boom and bust cycles. These are not “a sideshow … they are the main story.” In an important reversal, the IMF economists conclude that capital controls can play a vital role in restraining these flows and calming market volatility.

The result, said the IMF researchers, yields “three disquieting conclusions.” First, neoliberal policies result in “little benefit in growth.” Second, they increase inequality, and third this “inequality can significantly lower both the level and the durability of growth.” The bottom line is that policymakers must be more concerned about rising levels of inequality and take active measures to redistribute income, even if that includes taxes and boosting government spending. The authors conclude that “the fear that such policies will themselves necessarily hurt growth is unfounded.”

This is not a repudiation of the entire neoliberal agenda. The authors rightly note that opening markets and the trade that it has produced has bettered the lives of hundreds of millions, if not billions, of people. Foreign investment has spread knowledge and technology and spurred growth and prosperity. Market forces can be and often are more efficient than government decision-makers.

As populist politicians the world over rail against freer trade, it is likely that the IMF’s reflections will be misused. But while doctrinaire neoliberalism is no cure-all, neither is protectionism. In fact, economical orthodoxy in all forms should be resisted. A little eclecticism will go a long way; even more valuable will be increased attention to growing inequality.