The Neoliberal Straight-jacket and Economic Hardship in the West

June 5, 2012

Millions of people are being made jobless in Western economies due to the obsession with neoliberal economics amongst Western policy elites. I would like to argue that the West is in decline relative to powers like China because of a lack of openness in economic thought. This may sound like a contradiction – surely the West is much more open in terms of the spread of new ideas in political thought? However, economic policy in the UK, in the US and in agenda-setting economics institutions like the World Trade Organisation, has long been dominated by neoliberal economics. The comparison with China is not to bemoan its rise nor to commend its authoritarian leadership, it is rather to highlight that neoliberalism does not have to be the only game in town. China has skilfully played globalisation to its advantage by accepting a key role for the state, lifting many millions out of poverty in the process (although there’s still a long way to go), something which political parties are offering less frequently in the West whilst instead promising the rapid dismantling of the government’s role in the economy.

By neoliberal economics I mean, primarily, excessive free-trade, low taxes, small government and the globalisation of finance. As Harvard professor Dani Rodrik forcefully shows in his 2011 book The Globalisation Paradox – where he argues for a return to a modified version of the Bretton-Woods regime – China’s policy-makers have shielded themselves from globalisation’s rigours in key areas and have maintained manoeuvring space to powerfully influence the fortunes of their economy for the better. Unlike the West since the 1970s, China has followed more of a Bretton-Woods approach to trade. (This approach was born from a meeting of the victors of WWII in New Hampshire towards the end of the war, and emphasised open international markets but with leg-room for domestic policy to ensure full employment.)

For example, consider the Chinese approach to international trade in manufacturing, as Rodrik writes:

“The Chinese leadership resisted the conventional advice in opening their economy, because removing barriers to trade would have forced many state enterprises to close without doing much to stimulate new investments in industrial activities. Employment and economic growth would have suffered, threatening social stability. The Chinese decided to experiment… In particular, they relied on Special Economic Zones (SEZs) to generate exports and attract foreign investment. Enterprises in these zones operated under different rules than those that applied to the rest of the country; they had access to better infrastructure and could import inputs duty-free. The SEZs generated incentives for export-oriented investments without pulling the rug from under state enterprises.”

The point is not that China closed its borders to global trade, rather it played global trade and investment to its advantage. Foreign investors played a key role in the development of SEZs but the Chinese government made foreign firms form joint ventures with local firms producing products such as mobile phones and computers, so that innovative technology could be embedded into Chinese operations. China used government support to build an industrial base and then gradually opened up to foreign influence when it was ready.

Another example of where China has been smart with globalisation is in its cautious approach to financial globalisation (the liberalisation of restrictions on the movement of capital across borders). Since 1997 powerful organisations like the IMF have pushed aggressively for the scrapping of financial controls. The theory in favour of financial globalisation is that capital should be allowed to flow in and out of countries with as much ease as trade in goods and services, as this will act as a powerful competitive pressure, flushing out structural inefficiencies in economies (whilst also benefitting Wall Street and the City of London rather nicely). Strangely, the IMF was calling for this at the time of the Asian financial crisis when Indonesia, Malaysia, the Philippines, South Korea and Thailand suffered recessions due to investor panic. In 1996 these countries were the darlings of the financial world, experiencing a net inflow of $93bn. In 1997 they experienced a net outflow of $12bn despite most economists believing the structural elements of their economies were sound. China has not followed this route. It has largely followed the Bretton-Woods design on financial flows, by restricting the amount capital that can flow in and out of China from foreign investors, and in not floating its currency on international markets. Thus China’s economy has not suffered from the harmful effects of a volatile currency that swings according to what professor Rodrik describes as “the bouts of euphoria and pessimism” seen in financial markets.

Contrast China with a country like the UK. The UK’s currency has had a torrid time on financial markets. Since its floating in 1973, it has not been uncommon for the pound to experience 10-15 per cent changes in its value, a volatility which follows little rhyme or reason. This has hit UK exports badly. No wonder the UK has a massive trade imbalance. However, what is more worrying for Western countries like the UK is that the economic policy debate is so adverse to government taking a lead. The coalition government in the UK and other European governments have pursued destructive austerity measures which assume that the private sector will magically step in to provide jobs for the millions unemployed as a result. Yet this has not happened. I would argue that this is because of the dominance of neoliberal economic thought which holds that the market is the best provider of jobs and justice. Yet surely the success of Asia shows that the government can have an extremely valuable role to play, especially if this is combined with harnessing the advantages globalisation offers.

It is time democracies played their intended function of debating a variety of ideas, rather than being straight-jacketed by a doctrine which allows no room for practical measures to get the best out of globalisation. It is time to realistically strive for full-employment once again.


By Matthew Lomas