When debating this issue, John Quiggin (September 27, 2008) made the claim that neo-liberalism had failed (relative to social democracy). Paul Frijters (recent Club Troppo piece), on the other hand, dismisses the topic as largely irrelevant.
One reason for this disagreement is that one is defining economic libertarianism and the other is defining economic liberalism. Let me explain.
When Quiggin attacked neo-liberalism, he defined its core on three criteria.
- to remove the state altogether from non-core functions such as the provision of infrastructure services;
- to minimize the state role in core functions such as health, education, income security, through contracting out, voucher schemes and so on; and
- to reject redistribution of income, except as is implied by the provision of basic safety.
On those three grounds, he rightly notes that most democracies, in trying to pursue a free market line, have failed. Social democrats have proved far superior. These are all anti-economic libertarian arguments.
However, I prefer to make a clear distinction between economic libertarianism and economic liberalism.
Economic libertarianism justifies its stance on two grounds:
- individual liberty is a paramount virtue in itself and should generally override other virtues (a value-based, philosophical case); and so they are willing to support measures which enhance economic freedom even if these offer little or no economic gain or even involve an economic sacrifice.
Economic liberalism is a quite different kettle of fish. They are driven by their professional beliefs which is why we find that a majority of economists embrace many strict left wing views.
Let us look at the three areas that economic liberals like to focus on small government, barriers to intercourse, and labour market regulation.
There is absolutely no agreement between economic liberals and libertarians on the issue of small government low levels of government expenditure and taxes. The reason is simple: neither economic theory nor empirical evidence point firmly to any optimal size of government from an economic viewpoint. Depending on the starting point and, most importantly, on the nature and composition of government spending, smaller government does not necessarily or predominantly produce higher per capital incomes – except at the extreme fringes. So whereas libertarians endorse any proposals which reduce the size of government, economic liberals look at each proposal on its merit to see if it meets their economic test. The most striking example is in the analysis of distribution incomes. Small government is not mainly an issue in economics at all.
Turning to the second proposition (barriers to intercourse), economic liberals often start with the assumption that (subject to the usual provisos about availability of information and third party effects) that individual consumers are the best judges of their interest and that they are able to successfully maximize their utility or preferences (rational man). Even allowing for the new and mushrooming field of behavior economics, these assumptions are seen by economists as offering a sufficient approximation to reality.
This then induces them into reforms designed to remove competition barriers in product, service and financial markets. Economic liberals like such reforms because they believe competitive markets give sellers strong incentives to minimise costs, innovate and to channel goods and services to those consumers who value them most highly all conducive to higher economic welfare and national productivity. And their empirical studies generally show that: removing such barriers to competition does generally deliver better outcomes for employment and per capita incomes.
However, economic liberals differ from libertarians in two key respects:
- they do not see an expansion of economic freedom as desirable per se: an expansion of freedom only wins their support if it meets the economic test i.e. if it is confidently expected to yield significant net economic benefits; and
- they are much less cynical and distrustful of the ability of governments to correct market failure.
This means they look very closely at the empirical evidence.
So what has now happened to the idea of financial regulation?
The Campbell Committee of 1981 paved the way for financial deregulation of credit flows, interest rates and exchange rates. These are all just as necessary today as they were then. But the Committee also recognized that a financial system could not operate effectively unless investors at large had confidence in the underlying solvency of financial institutions and in the overall stability of markets. So it insisted on adequate prudential disciplines. Two subsequent Inquiries into the financial system reinforced this message. As a result, we have some very tough prudential disciplines in place (apart from deposit insurance, which has now been rectified).
Unfortunately the rest of the world did not follow suit. It can be said that there is surely now a strong need for additional regulation. However, while market failure and the greed of entrepreneurs are mostly responsible for what has happened, some of the things that went wrong were also due, on a smaller scale, to over-protection of consumers. And many forms of financial regulation such as a permanent ban on short selling would make markets more volatile. And monetary policy has to be held to account to an extent. These are all semi-government failures.
The third gap between libertarians and economic liberals is in the area of labour market freedom. Here too, as with small government, economics potentially clashes with ideology. Libertarians advocate labour market deregulation because it widens individual choice and this is seen as desirable for its own sake. On the other hand, economic liberals support deregulation of the labour market only where it is expected to produce economic benefits. And they know that the relationship between labour market deregulation and economic performance is very complex and does not lend itself to generalisations. In particular, they know that the economic impact depends on what exactly is being deregulated and how much labour market freedom there was at the start.
To sum up, economic liberal arguments still revolve around the case for lowering the barriers to intercourse (lowering protection, freeing up markets etc.) and for or against the dissolution of wage deregulation. The arguments on both these fronts remains wide open.
Although I mostly agree with John Quiggins views on labour market protection, I remain some distance from him on barriers to intercourse except of course in the area of financial deregulation, where trust matters most.