Milton Friedman must be rolling over in his grave. The economic ideas he espoused throughout his life have imploded in a spectacular fashion. Keynesianism which he derided has thus far withstood the test of time. Friedman's ideas were packaged to the world as part of the Washington Consensus.
"Washington Consensus" as a term was first coined by an economist working in the Institute of International Economics. It proposed ten recommendations which were:
- Fiscal policy discipline.
- Redirection of public spending from subsidies (specially those defined as indiscriminate) towards provision of pro-poor, pro-growth policies like primary education, primary health care and infrastructure development.
- Tax reform aimed at broadening the tax base and reducing the marginal tax rate to "moderate" levels.
- Market determined interest rates.
- Competitive exchange rates.
- Trade liberalization.
- Liberalization of inward foreign direct investment.
- Privatization of state enterprises.
- Deregulation i.e. abolition of regulations that impede market entry or restrict competition.
- Legal security of property rights.
These policies were strongly supported by international financial institutions like the World Bank and the International Monetary Fund. However, these proposals degenerated quite rapidly into market fundamentalism. The key characteristic of market fundamentalism is a strong, indeed dogmatic belief that markets tend towards a natural equilibrium and the best interests in a society "are achieved by allowing its participants to pursue their own self interest" (Wikipedia definition).
There are a few assumptions at play in both points of view and in market fundamentalism in particular. First of all, the fundamental assumption in the belief in the efficacy of markets is the assumption that conditions of perfect competition exist in all cases. Perfect competition assumes that there are no barriers to entry and exit, buyers and sellers have equal (and perfect) information and both parties have the same (or at least similar) economic power. These are all highly unrealistic assumptions. There is no market in the world where these conditions apply. The nearest approximation we come to are the stock exchanges and even there not all the assumptions hold true.
There is another problem with market fundamentalism. It assumes that everyone is either a buyer or a seller and that all buyers and sellers find each other. In other words, markets will find their own level of employment which may or may not correspond to full employment although the underlying assumption is that this will result in full employment. People who cannot play either role are ignored and under conditions of perfect market fundamentalism will be left to their own devices. The implicit assumption here is that buyers and sellers have access to the same amount of information regarding the transaction.
Friedman advocated a set of policies that have proven to be deeply unpopular everywhere. Furthermore, they have failed repeatedly in country after country where they were imposed. Take two test cases: Chile and Argentina.
Chile was the first country where the full weight of the Washington consensus and market fundamentalism was imposed. The country's murderous ruler Pinochet was assured that imposing these policies would result in short term pain but long term gain. How short is short term? The answer given was in months. The reality proved to be somewhat different. The downturn lasted several years instead of the promised months. A large number of people were thrown out of work. Poverty increased sharply along with income inequality. The local business community which had strongly supported the coup found itself at a severe disadvantage vis-a-vis foreign competitors for whom the economy was thrown wide open. Government revenues collapsed. The promised utopia never arrived. Instead, after a few years, the government found itself nationalizing the entire banking sector to save it from complete collapse.
Argentina was a similar case. To a greater extent than Chile, the country was a poster child for the IMF. This is the one country which followed the dicates of the consensus and market fundamentalism faithfully. The result was repeated economic collapse. In the nineties, the government went to a much further extent than previously in following the dictates of the IMF. For several years, Argentina was touted as a success story. This was a country which had become lean and mean. A country which had laid the foundations for long term success. And then the whole edifice came crumbling down. The foundations turned out to be built of sand. Economic growth was only achieved after Argentina defaulted on its debts and repudiated the recommendations of the IMF.
The 1997 Asian crisis too was a result of the consensus and market fundamentalism. Under pressure from the World Bank and the IMF, the Asian tigers loosened capital controls allowing so called hot money to come roaring in. For some time all was hunky dory. Foreign capital flowed in and massive investments were made in different sectors specially real estate. Then a rumour started concerning economic weakness regarding Thailand and suddenly all the hot money that had come roaring in was abruptly yanked out leaving economic devastation in its wake. The countries that were not affected were those which had resisted the pressure to loosen capital controls. Amongst the tigers, the one exception was Malaysia which rejected IMF advice and imposed capital controls. Other countries accepted IMF's advice and suffered from massive downturns. By contrast, the downturn in Malaysia was shallower and growth resumed more quickly and at a faster pace as compared to the other tigers.
Look at the situation today. The global financial system faces collapse and threatens to take the global economy down with it. In each and every case, markets have completely failed to find their equilibrium. Even Alan Greenspan has recently admitted the failure of the self regulating markets paradigm. Again it boils down to the assumptions made by market fundamentalism. Economics assumes conditions of perfect competition in order to make analysis of supply and demand easier. However, real world markets do not behave like this. Especially under free market fundamentalism, the effect of unfettered competition is actually to increase concentration and reduce consumer choice as larger firms swallow smaller ones. This increased concentration results in asymmetric information. Buyers generally do not have the amount of information that sellers have. This results in greater power accruing to the seller. As various scandals over the years have shown, such power is inevitably abused.
The financial crisis of 2008 has shown that the set of policies advocated by Friedman and the market fundamentalists results in an economic disaster of massive proportions. The policies taken to combat this crisis are in direct contradiction to those of the consensus and are more in line with those of Keynes. Thirty years of market fundamentalism have shown the economic philosophy (if it can be called that) to be a house of cards which cannot withstand the test of time.
There are a few assumptions at play in both points of view and in market fundamentalism in particular. First of all, the fundamental assumption in the belief in the efficacy of markets is the assumption that conditions of perfect competition exist in all cases. Perfect competition assumes that there are no barriers to entry and exit, buyers and sellers have equal (and perfect) information and both parties have the same (or at least similar) economic power. These are all highly unrealistic assumptions. There is no market in the world where these conditions apply. The nearest approximation we come to are the stock exchanges and even there not all the assumptions hold true.
There is another problem with market fundamentalism. It assumes that everyone is either a buyer or a seller and that all buyers and sellers find each other. In other words, markets will find their own level of employment which may or may not correspond to full employment although the underlying assumption is that this will result in full employment. People who cannot play either role are ignored and under conditions of perfect market fundamentalism will be left to their own devices. The implicit assumption here is that buyers and sellers have access to the same amount of information regarding the transaction.
Friedman advocated a set of policies that have proven to be deeply unpopular everywhere. Furthermore, they have failed repeatedly in country after country where they were imposed. Take two test cases: Chile and Argentina.
Chile was the first country where the full weight of the Washington consensus and market fundamentalism was imposed. The country's murderous ruler Pinochet was assured that imposing these policies would result in short term pain but long term gain. How short is short term? The answer given was in months. The reality proved to be somewhat different. The downturn lasted several years instead of the promised months. A large number of people were thrown out of work. Poverty increased sharply along with income inequality. The local business community which had strongly supported the coup found itself at a severe disadvantage vis-a-vis foreign competitors for whom the economy was thrown wide open. Government revenues collapsed. The promised utopia never arrived. Instead, after a few years, the government found itself nationalizing the entire banking sector to save it from complete collapse.
Argentina was a similar case. To a greater extent than Chile, the country was a poster child for the IMF. This is the one country which followed the dicates of the consensus and market fundamentalism faithfully. The result was repeated economic collapse. In the nineties, the government went to a much further extent than previously in following the dictates of the IMF. For several years, Argentina was touted as a success story. This was a country which had become lean and mean. A country which had laid the foundations for long term success. And then the whole edifice came crumbling down. The foundations turned out to be built of sand. Economic growth was only achieved after Argentina defaulted on its debts and repudiated the recommendations of the IMF.
The 1997 Asian crisis too was a result of the consensus and market fundamentalism. Under pressure from the World Bank and the IMF, the Asian tigers loosened capital controls allowing so called hot money to come roaring in. For some time all was hunky dory. Foreign capital flowed in and massive investments were made in different sectors specially real estate. Then a rumour started concerning economic weakness regarding Thailand and suddenly all the hot money that had come roaring in was abruptly yanked out leaving economic devastation in its wake. The countries that were not affected were those which had resisted the pressure to loosen capital controls. Amongst the tigers, the one exception was Malaysia which rejected IMF advice and imposed capital controls. Other countries accepted IMF's advice and suffered from massive downturns. By contrast, the downturn in Malaysia was shallower and growth resumed more quickly and at a faster pace as compared to the other tigers.
Look at the situation today. The global financial system faces collapse and threatens to take the global economy down with it. In each and every case, markets have completely failed to find their equilibrium. Even Alan Greenspan has recently admitted the failure of the self regulating markets paradigm. Again it boils down to the assumptions made by market fundamentalism. Economics assumes conditions of perfect competition in order to make analysis of supply and demand easier. However, real world markets do not behave like this. Especially under free market fundamentalism, the effect of unfettered competition is actually to increase concentration and reduce consumer choice as larger firms swallow smaller ones. This increased concentration results in asymmetric information. Buyers generally do not have the amount of information that sellers have. This results in greater power accruing to the seller. As various scandals over the years have shown, such power is inevitably abused.
The financial crisis of 2008 has shown that the set of policies advocated by Friedman and the market fundamentalists results in an economic disaster of massive proportions. The policies taken to combat this crisis are in direct contradiction to those of the consensus and are more in line with those of Keynes. Thirty years of market fundamentalism have shown the economic philosophy (if it can be called that) to be a house of cards which cannot withstand the test of time.
