Hurrah for the neoliberals

There has been an interesting discussion taking place between Paul Krugman and Scott Sumner on the changes which effected most of the world in the late 1970 onwards. Exemplified by Reagan and Thatcher the neoliberal revolution saw big changes in the way economies were organised across most of the world. Scott Sumner summarises the changes thus:

1.  Sharp cuts in the top [Marginal Tax Rates]

2.  Deregulation of prices, trade and market access

3.  Privatization of state-owned enterprises, services, and infrastructure

The first of these, tax cuts, are shown in the below Graph from Paul Krugman. The top rate fell from over 90% at the start of the Korean War to lower than 30% under Reagan.


I don’t in reality have much of a problem with most of these reforms, at least as Sumner describes them as opposed to their real world implementation.

Marginal tax rates of 90% don’t raise as much money as lower tax rates. Tax rates that high are only good for discouraging behaviour – perhaps I’d want a 90% tax on Heroin sales if it became legal, but I don’t want to discourage earning. The growth of trade and the liberalisation of product and service markets have made us all wealthier. There’s no reasons I can think off for tariff barriers between the UK and France or why the US should protect its car makers from Japanese imports, we are all one people aren’t we? [1] Privatisation has had some negative impacts in this country, but there’s nothing intrinsically good in a state owning a steel manufacturer. [2] Singapore owns its eponymous airline but its run as a private capitalist enterprise and British Leyland wasn’t exactly run particularly well.

But that’s not what is important.

What has inspired Krugman to remark has been the ideological blindness many on the right show when confronted with “an era of high taxes on the rich and extensive regulation, during which living standards experienced extraordinary growth; and an era of low taxes on the rich and deregulation, during which living standards for most Americans rose fitfully at best.” As Brad DeLong cruelly puts it Scott Sumner goes on to answer a different question, but the answer he gives is interesting nonetheless.

Sumner argues that this growth slowed because technological progress slowed and free market reforms helped us to keep growth going, even though it was weaker than what it was.

Here’s what I think happened.  There were a few underlying technological developments in the late 19th century that dramatically affected living standards in the 1920-70 period, when they were widely adopted in advanced economies.  I would certainly include electric power and the internal combustion engine.  I also think indoor plumbing is underrated.  Imagine having to rely on outhouses in cold climates.  And also recall the health advantage of safe drinking water.  And I suppose modern chemistry should be included—something I know little about.  Many key products were first invented in the late 1800s or early 1900s (electric lights, home appliances, cars, airplanes, etc) and were widely adopted by about 1973.  No matter how rich people get, they really don’t need 10 washing machines.  One will usually do the job.  So as consumer demand became saturated for many of these products, we had to push the technological frontier in different directions.  And that has proved surprisingly difficult to do.

Further to this argument, this trend is clear in medicine. Kidney dialysis, chemotherapy, effective anaesthetic, in fact most of the medicine which gets us to our 70s was invented in this golden age. A lot of the rest of medical research since just hasn’t been as effective at lengthening our lives, or improving its quality.

Scott Sumner doesn’t refute or want to refute that growth in the Golden Age really was better than it has been since, but he does argue that the neoliberal reforms since the 1970s (in truth, started under Carter and Callaghan) have ensured we have seen better growth than we would have done had without those reforms. Scott Sumner points out that growth slowed everywhere after the 1970s, but it slowed the most in countries which reformed their economies the least. He presents us with data to illustrate what he means. Below is a table showing the GDP of selected countries relative to that of the US.

Country       1980        1994      2008

USA              1.000      1.000    1.000

Australia      .841        .770      .837

Canada        .905        .818      .843

Britain         .688         .705      .765

France         .780        .730      .713

Germany     .803        .812       .763

Italy             .756        .754      .675

Sweden       .868        .777      .794

Switz.          1.146      .987       .915


HK                .547      .845        .948

Japan          .732      .815         .736

Singapore   .577      .899       1.064

Latin America

Argentina     .395     .300       .309

Chile            .210     .251        .311

Note that four countries gained significantly on the US, two were roughly stable (Australia, Japan) and the rest regressed.  The four that gained were Chile, Britain, Hong Kong and Singapore.  Of course lots of poor countries gained on the US, but that’s to be expected.  But I will show that the performance of every single country on the list is consistent with my view that the neoliberal reforms after 1980 helped growth, and inconsistent with Krugman’s view that they did not.

Krugman responds to Sumner’s post arguing that there is more in the data than Prof Sumner would care to admit. Catch up before the 1980s was due to the adoption and spread of new technologies and productive techniques in the developed world. In the 1970s…

…the long-run trend of taking productivity gains out partly in the form of shorter working hours came to an end in the US, while continuing elsewhere. What that’s about is the subject of dispute, but it’s important to understand that a large part of the GDP difference between the US and Europe reflects that choice. France, in particular, is a country with about the same level of technology and productivity as America, but with roughly 25 percent lower GDP per capita; this mainly reflects longer vacations and earlier retirement, which may or may not be bad things, but are not a straightforward case of inferior performance.

Regardless to say, it is a very complicated subject. Moreover, one of the biggest changes which occurred in the last quarter of the 20th Century was a profound change in monetary policy which is somewhat separate from MTR and the relative size of the state.

So at this point I thought I’d step in with a few thoughts of my own.

I don’t think that the neoliberal reforms which Scott Sumner describes are the best explanation as to why some countries grew more strongly than others after 1980s. For example, 100% of the countries which did not catch up with the US, the most ardent neoliberal reforming country listed, are not the US and do not enjoy the exorbitant privilege the US enjoys because the dollar is the reserve currency of the world. This probably didn’t matter when the main problem was catching up from post-war lows, but would begin to have a larger affect once the non-US country’s GDP came close to that of the US.

Furthermore, three of the states which gained on the US following 1980 – Britain, Hong Hong and Singapore – act as global financial hubs. This is not a growth model which can be replicated, the clustering that has made London a financial powerhouse just isn’t feasible in other states. This wouldn’t matter too much I suppose, but the period after 1980 has seen financial-industry profits outperform those of other industries.

Like Krugman, it seems that leisure choices certainly do make a difference. For example, I get the statutory minimum of 20 days holiday in a year whereas in the US there is no such minimum. I also think the existence of the Euro [3] will have dampened the growth potential of those who have adopted it. The countries which adopted it were far from being an optimal currency area and some suffered from interest rates too low and some too high. So political decisions, which are not easily characterised as neoliberal or not, also impacted on growth.

What can we take from this?

First of all, it is clear that a technological frontier of some sort had been reached and that this contributed to the collapse of the post war settlement . Moreover, as the post war settlement reached this technological barrier political momentum swung from left to right, spearheaded by Thatcher and Reagan. A more open economy certainly helped to maintain growth but evidence that explicitly neoliberal reforms pushed this and resulted in higher growth is not as compelling as I think Sumner presents it. Krugman’s inadvertent implication that no reforms to post war settlement were required is also demonstrably false, although I do not believe this is his view.

Another lesson is on how little difference alternative policy regimes make to GDP. Chris Dillow suggests that “at least within the wide parameters set by actually-existing mixed capitalisms – policies (or at least those that have been tried) might not make much difference to trend growth.” This is grist in the mill for Marxists who want to argue that you cannot reform capitalism but must abolish it, but it should also give pause to those who argue that the state must do this or that, I think you’ll find it is a bit more complicated than that.


[1] I do make exceptions to my free trade predilections for developing countries but that is a different story.

[2] Again, I do make exceptions for developing countries, it may be difficult to coordinate investment in steel and mining and chemicals etc without a visible hand taking on some of the risk: see Gerschenkron on state acitivsm and development and probably Rodrik on the under-supply of entrepreneurs in developing economies.

[3] Is the Euro a neoliberal policy? The ECB is an inflation hawk so I suppose this puts it in the neoliberal arena, but the supposed safety of the Euro was exploited by states to be profligate which should lead us to question how neoliberal a common European currency should be regarded.