The Neoliberal Revolution

A new book gives Hayek, Friedman, and others too much credit—and too little.


Masters of the Universe: Hayek, Friedman, and the Birth of Neoliberal Politics, by Daniel Stedman Jones, Princeton University Press, 424 pages, $35

The 20th century saw two great economic revolutions: socialism and neoliberalism.

Socialist ideas were already floating around the democratic West in the early 1900s, but they gained much greater popularity after the Great Depression, which was widely seen as a failure of capitalism. One part of this shift entailed a greater role for the government in regulating or owning business enterprises. The second part involved a major expansion of social insurance programs.

Beginning in the late 1970s, there was a backlash against excessive government intervention in the economy. This neoliberal revolution involved privatization, deregulation, and cuts in marginal tax rates, but it left most social insurance programs in place.

Daniel Stedman Jones, an independent historian (and barrister) in London, has written a balanced and informative study of neoliberal thinkers such as F.A. Hayek and Milton Friedman, exploring their impact on policy making, particularly during Margaret Thatcher's administration in the United Kingdom and Ronald Reagan's in the United States. Jones suggests a policy revolution that began in the 1970s drew on 30 years of neoliberal research and advocacy, partly financed by businessmen hostile to Franklin Roosevelt's New Deal policies. Although Jones is skeptical of the more radical elements of neoliberalism, he is mostly respectful of the major neoliberal figures, despite the fact that his own politics are clearly left of center.

Jones traces the origins of neoliberalism to the mid-1940s, specifically to the nearly simultaneous publication of Hayek's The Road to Serfdom (1944), Ludwig von Mises' Bureaucracy (1944), and Karl Popper's The Open Society and Its Enemies (1945). The appearance of these highly influential books was followed by the formation of the Mont Pelerin Society, a group of American and European neoliberals who met annually starting in 1947. Even within this group there were important ideological differences, with Popper being much more sympathetic to the democratic left than Mises. Early neoliberals rejected complete laissez faire, which was widely seen as discredited by the depression; they supported economic interventions such as antitrust laws, the regulation of natural monopolies, health and safety regulation, and government provision of education and other social services.

Over time the center of the neoliberal movement shifted from Europe to America, especially the economics departments at the University of Chicago, where Milton Friedman taught, and the University of Virginia, where James Buchanan and Gordon Tullock developed "public choice" theory, which aims to explain why government policies often end up serving special interest groups. At the same time, the ideology drew closer to laissez faire. Neoliberal economists were less likely to endorse interventions such as antitrust and more likely to support a radical program of deregulation.

Beginning in the late 1970s, neoliberal ideas began to have a significant impact on policy in the U.S. and Britain. Under President Jimmy Carter there was significant deregulation of transportation, utilities, and banking, and capital gains taxes were reduced. Deregulation continued in the 1980s under President Reagan, who also slashed the top income tax rate from 70 percent to 28 percent. In Britain the Labour Party began to move away from traditional Keynesian stimulus programs, as these policies were widely blamed for the high rates of inflation during the 1970s. Thatcher sped up that trend after taking office in 1979. Her Tory government privatized state-owned firms and public housing, deregulated the financial industry, weakened labor unions, and sharply reduced the top income tax rate.

My reservations about Jones' study start with the term neoliberal, which is often intended as an insult when used by people on the left. Jones places neoliberalism within the framework of modern conservatism. I see neoliberalism as exactly what the name suggests, a new form of liberalism. It might be viewed as classical liberalism with a welfare state added on, or mid-20th-century liberalism without government ownership of industry and without regulation of prices and market access.

Jones is aware that the neoliberal revolution was often a bipartisan affair. "Too often," he writes, "the adoption of certain key [neoliberal] policies by Labour or Democratic administrations during the 1960s and 1970s is assumed by conservative commenters to have been a sham, or by left or liberal commenters to be a source of shame. These views miss important elements in the successes and failures of the neoliberal political project."

But in the end Jones accepts the standard left-wing complaint that neoliberalism eventually turned into what the Nobel laureate economist Joseph Stiglitz has called "market fundamentalism." In Jones' words, neoliberalism became the "elevation of the market to an almost theological status."

There is a grain of truth in this charge, but Jones misses the bigger picture for three reasons: He underestimates the extent to which neoliberalism was built on impressive economic research, he overstates the extent to which neoliberalism became associated with modern conservatism, and he overstates the neoliberals' opposition to government. Most of the neoliberal critique was aimed at specific statist policies, such as nationalization and regulation, not at "big government" per se.

Consider Jones' description of neoliberalism's evolution from the late 1940s to the '70s: "The early neoliberals were marked by their desire to move beyond both laissez-faire economics and the New Deal. Later neoliberals, defined by the Chicago emphasis on unregulated markets, were less ambiguous in their opposition to the welfare state and to the need for government intervention in the economy."

In political practice, neoliberalism was not about abandoning the welfare state. It was about deregulation, privatization, freer trade, lower marginal tax rates, and keeping inflation under control. Thatcher's policies were viewed as a big neoliberal success, despite the fact that government spending remained close to 40 percent of GDP. There is far less regulation of investment, trade, market access, and prices in developed countries today than in the 1970s. Many state-owned enterprises have been sold to the private sector, and inflation has been brought down to relatively low levels. Virtually every developed country has sharply cut its top income tax rate from the levels of the 1970s. Yet the welfare state in those countries is roughly as large as it was four decades ago.

Nor was opposition to the welfare state ever a big part of the academic side of neoliberalism. I studied economics at the University of Chicago between 1977 and 1980, when the Chicago school had reached its peak of influence. There was a heavy focus on the failures of Keynesian demand-side macroeconomics as well as the often counterproductive effects of regulation. But if the welfare state ever came up, it was generally brushed aside with the comment that the optimal policy would probably be to just give money to the poor.

Milton Friedman proposed a "negative income tax" that would have replaced many welfare programs with direct cash payments. He also advocated vouchers for education and health care, plus a progressive consumption tax. Jones suggests that Friedman was opposed to both the welfare state and progressive taxes, but that's a bit misleading. What Friedman opposed was paternalism and inefficiency. At times Friedman indicated that his ideal society was a minimal state, but his policy recommendations would have given the government a substantial role in addressing issues such as health care, education, and income inequality. Hayek too supported a basic safety net.

A study by the libertarian political scientist Charles Murray in the mid-1980s did point to the pernicious effect of welfare on incentives, but the issue was not significantly addressed until the mid-1990s, when the welfare system was modified—under a Democratic president—to provide smaller benefits to the nonworking poor and more subsidies to the working poor. This wasn't a conservative plot to cut spending. It was an example of modern liberalism being transformed by academic research.

All the other major neoliberal initiatives in America were essentially bipartisan, including free trade agreements, cuts in capital gains taxes, the reduction of the top income tax rate, and the deregulation of transportation, utilities, and banking. Because big social programs such as Medicare and Social Security in America and the National Health Service in the U.K. are highly popular, criticism of the welfare state is often directed at relatively modest efforts aimed at groups not likely to vote for the more conservative party. Even as Mitt Romney complained about people "who are dependent upon government, who believe that they are victims, who believe the government has a responsibility to care for them," he campaigned vigorously against President Barack Obama's Medicare cuts.

Jones' focus on America and Britain leads him to exaggerate the affinity between neoliberalism and the right, since both countries elected relatively conservative administrations just as neoliberal ideas were gaining influence. If the study had focused on Australia and New Zealand, Jones would have described how a pair of labor parties radically transformed economies that had been hamstrung by regulation and barriers to trade.

In many respects the New Zealand Labour Party pushed its market reforms much farther than Thatcher did, and it did so without abandoning its left-wing commitments in civil rights and foreign policy. Indeed, by the 1980s and '90s virtually all countries were moving toward more market-oriented economic models, including those ruled by socialist and even communist parties. Because both Reagan and Thatcher are larger-than-life figures, people tend to overlook the quiet neoliberal revolution that was occurring simultaneously in many other corners of political life.

Jones does note that the Thatcher and Reagan administrations were products of their times. He acknowledges, for instance, that the backlash against Keynesianism in Britain actually began under James Callaghan's Labour government in the late 1970s. And in the early '80s the Thatcher government was initially reluctant to push neoliberalism too far.

The Tories' first efforts were focused on reducing inflation, not radical moves toward a more unrestrained market economy. The 1979 Conservative Party manifesto did not even mention privatization. As the 1980s progressed, however, the Tories were emboldened by neoliberal initiatives in other English-speaking countries, especially the U.S., and adopted a more extensive agenda of privatizing government enterprises and weakening labor unions. Jones points out that many Thatcher reforms were maintained after she left office and that the Labour Party "continued and deepened" them after 1997.

Jones often tries to distinguish a more pragmatic form of neoliberalism, whose policy reforms he sometimes supports, from a more far-reaching laissez-faire agenda, which he blames for major policy failures, including the financial crisis of 2007 to 2010. There is no question that free market ideology was ascendant in the latter part of the 20th century. But Jones presents no compelling argument connecting the crisis with "deregulation," other than vague references to the Glass-Steagall Act, derivatives, and other factors that are tangential to the subject. Progressives have an unfortunate tendency to call for more government intervention whenever they perceive a market failure, and they assume almost all failures are market failures, even those that stem from previous government interventions.

Specifically, government insurance creates moral hazard and encourages excessive risk taking. Neoliberal economists, aware of this problem, have proposed many regulatory reforms, such as breaking up the government-sponsored mortgage lenders Fannie Mae and Freddie Mac, reforming deposit insurance, and ending the "too big to fail" policy that encourages bailouts of financial institutions. Another neoliberal reform would require income verification and a minimum 20 percent down payment for all mortgage loans made with federally insured funds.

But the political establishment listens much more closely to the banking and real estate industries. Hence the authors of the 2,000-page Dodd-Frank bill neglected to ban subprime mortgages or rein in Fannie Mae and Freddie Mac, despite the fact that subprime loans were allegedly at the heart of the crisis. It's a perfect illustration of the "regulatory capture" argument developed by George Stigler at the University of Chicago and discussed by Jones.

All that said, Jones is right to suggest that a more dogmatic form of free market economics has been ascendant among conservatives in this century. For instance, Milton Friedman blamed tight money for the near-zero interest rates and depressed economy in the U.S. during the 1930s and Japan during the late 1990s. There is every reason to assume that if Friedman were still alive he'd again favor monetary stimulus over fiscal stimulus. Yet today most American and northern European conservatives have walked away from Friedman's argument that monetary policy is frequently too contractionary, moving toward a hard-money Austrian approach instead.

Nor is this shift confined to monetary policy. In just a few years conservative American think tanks have moved from embracing a health insurance mandate in Massachusetts (signed by Mitt Romney) to opposing a similar mandate proposed by Barack Obama. Among conservatives there is now much more suspicion of the welfare state and little support for a negative income tax. Conservative support for carbon taxes has declined. The euro crisis is seen by some on the right as an opportunity to dismantle many government programs in the Mediterranean countries, whereas Friedman would have blamed the crisis on the euro and called for the economies facing deflation to exit the euro and devalue their currencies.

Not all the changes to conservatism have moved the right in a more libertarian direction. Conservatives also have become increasingly hostile to immigration, which the early neoliberals saw as integral to an open society.

Jones should be applauded for trying to produce a balanced account of the neoliberal revolution. The book is not a conspiratorial view of the sort produced by the leftist writer Naomi Klein in The Shock Doctrine. But it hews too closely to the conventional wisdom that the neoliberals had some good ideas that transformed conservatism but that they went too far. It would be more accurate to say neoliberals transformed liberalism, and that there is much more work to be done on that project. It would be interesting to see Jones write a history of neoliberalism in Sweden and Denmark, where policies such as privatization, free trade, deregulated labor markets (in Denmark), and universal school vouchers (in Sweden) are still seen as highly successful.

In the end, Jones gives the neoliberals both too much credit and too little. Mainstream liberal economists probably would have eventually figured out how to stop inflation with something like the New Keynesian approach, even without monetarism. And it seems clear that the worldwide move toward privatization, deregulation, and lower marginal tax rates was driven mostly by pragmatic rather than ideological considerations, particularly in areas, such as Scandinavia, where laissez faire has little appeal. As is frequently the case, the neoliberals probably changed history less than either their opponents or supporters imagine.

At the same time, Jones underestimates the neoliberals' intellectual contributions. They were not merely advocates of monetarism and deregulation. They produced a mountain of very persuasive evidence that Keynesian and statist policies often did more harm than good. Given that between 1945 and 1970 they were often viewed as crackpots, their story is rather heroic. Just keep in mind that heroes are rarely as influential as they seem.