This article shall investigate the emergence of neoliberalism, with a specific focus on monetarism. I question the notion that neoliberalism embodies the fruition of a market mechanism over the state. Rather, the state has changed its role to meet the needs of the financial sector.
The emergence of monetary policy and the crisis the preceded it
Monetarism is, in its strictest sense, merely a government policy. Grounded in the quantity theory of money, monetarism restricts government economic policy to simply ensuring a fixed growth in the money supply in line with a growth in output. It represents a fundamental turn away from the Keynesian policies that preceded it. The Keynesian economic ideology, practised in its various forms, extends government economic policies to demand management. Through government managed investment and social welfare, the role of policy is to target full employment (Clarke, 1987).
Monetary policy is predicated on the notion that with stable prices the market provides optimal allocation of credit, both nationally and internationally. Thus the role of government to monetarists remained crucial, but its scope shrunk. In October 1979 when the US Federal Reserve announced a shift towards monetary policies, chairman Volcker suggested, “monetarism offered the right policy prescriptions at the right time” (Volcker 2002). In attempting to understand why these policies emerged it is, therefore important to locate monetarism within a historical context.
The post-war economies, haunted by the ghosts of the Great Depression, instilled the ‘embedded liberal’ consensus: a recognition of the role that Keynesian demand management played in economic and political stability.
Capital controls were considered necessary to prevent the policy autonomy of the interventionist Keynesian state from being undermined by speculative capital flows. Faced with the recognition that open trade in both goods and finance were not compatible, finance was sacrificed to secure stable exchange rates, that was considered crucial to the open trade that the US economy, in particular desired. This normative framework was encrusted in the Bretton Woods institutions, which were the architecture of the post war global political economy (Heillenier, 1994).
The so called Keynesian period between the end of the war and the 1960’s saw great progress in economic growth, social welfare and employment, alongside continued progress of technology and production in both the US and Western European economies.
However, the progress in technology and diffusion of productive techniques had increased competition and squeezed profits. Faced with declining profit margins businesses were forced either raise prices, or cut costs (labour). The tension between declining rates of capital accumulation and the Keynesian commitment to countercylical demand expansion, gave way to the dramatic inflationary hikes – UK inflation touched 15% in January 1981. This inflationary pressure saw the US abandon the gold standard and with it the fixed exchange rate pillar of the Bretton Woods architecture. Thanks to the unique structural power that the Bretton Woods agreements had offered the US, they could continue to expand demand without fear of a run-on the dollar, as the rest of the world still demanded dollars (Hudson, 2003). Yet, even with this devalued dollar, the Keynesian contradiction of expanding demand in times of declining capital accumulation, inflation, debt and unemployment, could not be repaired. Eventually, they abandoned expanding demand and focused on the supply-side of economic management – a stable inflation rate. Releasing caps on interest rate and allowing market mechanisms to organise the allocation of credit (Clarke, 1987).
Understanding the policy and ideological shift of the late 1970’s is, I maintain, crucial to understanding the political and economic landscape that we see today. An assessment of the competing classical market-led the critical class-led explanations sheds light on the changes that were taking place and their effects.
The Classical Explanation for Monetarism
The market-led case for monetarism rests on the classical economic notion that the ‘market knows best’. Yet this timeless rallying cry tells us very little about why monetary policy emerged when it did or how its effects were felt across the economy. As late as 1976, when the post-war picture of the world economy was being redrawn, the Bretton Woods framework of controlling capital movements and ensuring domestic economic autonomy was retained in the amended IMF Articles of agreement. Yet a number of structural changes in the financial market were undercutting the rationale for such controls (Goodman & Pauly, 1995).
I shall outline the market driven reasons that compelled financial liberalization.
Initially, with faith gradually being restored to the European economic order following the war, there was generally more confidence in financial transactions, which was essential for greater involvement in financial speculation Technological progress, particularly communications and container ships, had allowed an increase in international trade and a growth in multinational firms. These large firms engaged in both productive and financial activity and so demanded greater use of international financial services. Digital technology had amplified that mobility and fungibility of money that made instant transfers very cheap and almost untraceable (Heillenier, 1994). This made it easier for firms to adopt swift exit and evasion strategies from state regulation and aided the movement of money between competing countries in search of higher returns. Where governments were serious about restricting such flows, they ran the risk of sacrificing the domestic productivity of their firms by preventing offshore direct investments. This made the gradual easing of controls in advanced countries inevitable, as they sort increasing deregulation to ensure their firms remained competitive (Goodman & Pauly, 1995). The declining domestic profits and strong regulatory environment in the US had forced banks to abandon their domestic focus and look abroad, particularly to the Euromarkets for greater returns. In addition massive financial activity caused by the oil price shock in 1973. From an almost negligible level in 1950’s, financial transactions had reached over $1trn-a-day by the 1990’s (Heillenier, 1994).
The increasing complex market forces backed by technological improvement had, according to this market explanation rendered capital controls a costly and unproductive policy and compelled policymakers to allow market forces to best manage credit accumulation, allocation and distribution.
The problem with this overly teleological, naturalised conception of market forces is that is ignores the pivotal role that states play. “Politics, within distinct state structures remains the axis around which international finance revolves” (Pauly, 1988:2).
State led neoliberalism
The role of the state in neoliberalism is often misunderstood. Conventional support and critiques neoliberalism, through limiting government to monetary policy only entails “the shrinkage of the state to regulatory functions only, and then as minimal as possible” (Mason, 2008).
Neoliberalism, rather than reduce state activity in the economy has is a transformation of its functions. Where Keynesianist government intervention involved supporting demand and labour in the economy – through social welfare spending, minimum wages etc, neoliberal government intervention entails supporting supply side concerns – those of business.
Federal spending in the in the US in 1980 was $59bln, by the turn of the century it had almost tripled – to $1789bln. The neoliberal era had seen state swell to an unprecedented size, but rather than social security and welfare, the state spent enormous quantities on subsidising corporations and funding the military-industrial complex. In addition to limiting the power of labour unions the neoliberal state has privatised many of its national industries, even the flagship NHS in Britain, is being gradually hired out to private companies, with the state picking up the tab.
In terms of financial markets that the importance of the state can clearly be seen today where, in time of liquidity crisis, $700bln of US state funds are being employed to absorb unreliable assets and to try and prompt confidence in the ‘market system’ by signalling its role as a lender of last resort. The finance industry has successive crises, with increasing magnitude since the return to monetarism in the 1970s Crisis management, by the state is an essential part of the financial apparatus in both the US and the rest of the world (Heillenier, 1994). Its role however extends beyond this.
The policy choices that allowed greater financial liberalisation were first in evidence is the creation of the Euromarkets in the 1960’s. At the time when Bretton Wood’s controlled financial framework still held sway, this market was a regulation-free environment for multinational corporations and banks to operate in. A supposedly ‘offshore’, ’stateless’ zone, the Euromarkets could not have developed without the sponsorship of the US state and British government allowing it to function free of regulation in London (Heillenier, 1994).
This initial baby step to the financial liberalization we see today, required state authority for its creation, and again the US had to play an important role in its survival when the Euromarket’s were threatened in the early 1970’s. The speculative capital flows that were threatening Bretton Woods exchange-rate stability compelled Japanese and Western European governments to consider coordinated capital controls in both sending and receiving countries, as well as in through-flow zones such as the Euromarkets. The US, with its strong position in finance blocked these moves and further extended pressure on other countries to relax their controls (Heillenier, 1994).
This liberalisation, led by the US across the world did not extend to trade, partly because the unique mobility of money makes policy coordination and regulation very difficult but also because the US benefited greatly from international currency speculation. The status of the US Dollar, as the international reserve currency made finance critical to US interests (Hudson, 2003).
This is an essential contribution. Global financial markets, and globalisation in general is too often characterised as an economic zone, torn away from state control for businessmen and market interests to run rampant. Yet precisely the opposite is true, state authority has played the fundamental role in the creation, maintenance and expansion of the global financial structures that determine the content of the market. Why the US chose to restructure the US economy along these financial lines, rather than adopting more radical Keynesian options such as centralised capital accumulation is an important.
History is not compelled by theories and logic; no assessment of policy can end in the abstract. Consequences are crucial to understanding the theory of neoliberalism and monetarism and why they came about. While the outcomes varied, in line with the different practices of neoliberal theory in different countries, they can be broadly characterised by three features: raising inequality, raising debt, and, most significantly a return to the hegemony the financial industry.
‘Finance’ is a complex network of institutions behind which stand individuals. The choice of governments such as the US or Britain to adopt the policies that transformed the economy in a way which benefited finance was, its argued, dictated by the whims of financial institutions and the individuals who operate them – the financial class (Dumenil & Levy, 2001).
Rooted in Marxist orthodoxy this argument rests on the principle that capitalism recurrently evolves towards large structural crises (which today’s crash could arguably considered the latest expression of). Capital only reasserts its dominance at these times of turbulence through transformations of its basic functionings (Dumenil & Levy, 2001).
The policy response to the structural inflationary crisis of the 1970’s, shaped capital’s transformation in the US and Britain. The monetarist policy of price stability over full employment meant that the interest rate to jumped to 18%, in the US in 1981.This resulted in the redistribution of profits from non-financial companies to the financial sector. In the US non-financial corporations were gifting almost a third of their profits to financial institutions through real interest payments throughout the 1980’s. Profit rates of US financial corporations, consequently, grew throughout that period to stand 10% higher than that of non-financial companies by the end of the 1990’s. Over the same period indebted developing countries, who had received large cheap loans in the 1970’s ended up transferring large proportions of wealth to financial corporations in the US and elsewhere, following the monetarist interest rate shock (Dumenil & Levy, 2001). Crucially “most of this profit is not generated from financing productive business: the world’s total stock of financial assets is three times as large as global GDP. In 1980, it was about equal to GDP” (Mason, 2008).
The key implication of this argument is that the sudden interest rate rises prolonged the effects of the crisis, as benefits from the recovery of firms profitability were transferred to lenders and diverted from employment and investment (Dumenil & Levy, 2001).
The class implications cannot be ignored. Between 1947 and 1973, the Keynesian era, the income of the poorest fifth of US families grew 116%, higher than any other group. Over the last three decades, while growth has averaged 1974 to 2004 it grew by just 2.8%. With declining real wages, debt has had to finance household spending. Personal household debt in the US now represents 98% of GDP, whereas in 1979 this figure was just 46%.
Any analysis that discounts the benefits and losses of certain interests group cannot be considered whole, which is why the Marxist approach here remains essential.
The recent financial crash has, momentarily at least, opened the intellectual space to question the dominant ideology that has ruled for the past three decades. Even Britain’s most conservative paper, The Daily Mail felt the need to run a double page spread titled “In defence of Capitalism” (Daily Mail, 25/09/08). Emerging economies, challenge the hegemonic status of the US, increasing the likelihood of protectionist responses. The British government is excising some leverage over financial corporations by directing their interest rates downwards, and new president elect Barack Obama had discussed measures for state supported public healthcare and a raise in the taxes of the richest.
However, when the ‘nationalised’ UK bank Northern Rock, repossess houses in order to secure the salaries of its directors, notions of a transformation of the state to support social justice over business interests, remains dubious.
