Neoliberalism Comes Unglued
By Mark Weisbrot
With the stock market plummeting, an economic and political crisis
in Russia, and a regional depression in Asia, a lot of people are wondering if we are
staring into the abyss. It’s no longer just the left, which has predicted six out of the
last three world economic crises, that is nervous. "We are in a situation which is
indeed a dangerous one, not fully rational," said IMF managing director Michel
Camdessus. And Federal Reserve Board chair Alan Greenspan also warned that "it is
just not credible that the United States can remain an oasis of prosperity unaffected by a
world that is experiencing greatly increased stress."
The latter statement could be contested. The United States still
consumes 88 percent of what it produces, and could, with the right policies, protect its
population from adverse economic events in the rest of the world. As much as our political
leaders would prefer to let the tail wag the dog–subordinate the domestic economy to the
needs of international commerce–they are still a long way from transforming the U.S.
economy where our fiscal or monetary policies are externally constrained. The dollar lost
a third of its international value between 1985 and 1988, and this had no adverse effect
on the U.S. economy. In other words, the Fed could lower interest rates as far as it
wanted to, in order to keep the U.S. out of recession. Unlike most other nations, we would
not have to worry about the inflationary impact of any currency depreciation that might
result. We could also run federal budget deficits, if necessary, for the purpose of
maintaining economic growth and employment.
It is important to keep this in mind, not because we are close to
having a government that would put the needs of its people ahead of the big bondholders or
transnational capital. But they should be held accountable, and not be able to shift the
blame to nebulous unseen forces of "the global economy." Greenspan’s
announcement last week that he would consider lowering interest rates is a positive sign,
but it remains to be seen whether the Fed’s action will, as has happened in the past, end
up being too little and too late.
The events that have dominated the headlines of the economic news
are not as interrelated as they appear to be. To get a handle on what is happening, it is
worth trying to sort them out a bit.
The Stock Market’s Decline
The Dow is down about 16 percent since July
17, and this is commonly attributed to events in Russia and Asia. But this is very
misleading. The fact is that stocks were, and still are, grossly overvalued relative to
the earnings of the underlying assets they represent. When this happens, decline is
inevitable, and the external event that triggers the decline does not "cause" it
in any meaningful sense of the word.
It is not that difficult to show that stock prices have been
inflated into a speculative bubble. Dean Baker of the Economic Policy Institute has done
the necessary arithmetic, in the course of refuting the exaggerated claims–regarding
potential stock market returns–made by those who seek to privatize Social Security.
Stock prices can bounce all over the place in the short run, as the
market is driven by psychology. But ultimately stocks only have value because the
companies they represent earn profits. People forget this sometimes, and then remember it
when the market plunges–much as drivers in Washington DC seem to re-learn how to drive in
the snow and ice each winter.
There are two sources of income from holding stocks: first, a
dividend payout, which represents the shareholder’s portion of the companies profits
(earnings). The average dividend payout is currently about 2 percent. The other source of
income is from an increase in the price of stocks or capital gains. The question is, how
much can stock prices increase?
The average price to earnings ratio is still at a record high, even
after the recent plunge. So it is safe to assume that prices will not increase faster than
earnings. Earnings, however, cannot increase much faster than the growth of the
economy–unless we think that there is going to be a continuous redistribution of income
from labor to capital. Some of that has happened–the share of national income going to
corporate profits has increased by 3.2 percentage points since the last business cycle
peak (1989). The typical worker would be earning about $1,100 more annually today if not
for that shift. But no one is projecting this trend to continue, and real wages for the
majority of the work force have begun to rise significantly during the last two years.
So if stock prices cannot grow faster than earnings, and earnings
cannot grow faster than the economy, then we would expect stock prices to grow at about
the same rate as the economy. Over the next decade, economic growth is projected to be
about 2 percent annually. If we add that to the dividend payout, we get a rate of return
on stocks of 4 percent a year, maybe 4.5 percent if the economy grows a little faster.
So why would anyone hold stocks if they can get almost the same
return on a short-term bond, with virtually no risk? Well, they might not have seen this
arithmetic. If we look at who has done what in the last few market downturns, it has been
overwhelmingly the small investors buying and the big players selling. But even for those
who know they are sitting on a bubble, there is an enormous temptation to stay in as long
you expect others to buy enough to keep driving prices up, so long as you can jump before
everyone else does. But that’s easier said than done, and of course most people won’t be
able to pull it off; such is the nature of bubbles, manias, and other excesses of markets
All this analysis shows us is that the stock market’s decline is not
the result of events in faraway places. It is, however, a truly significant event that
might well herald the end of an era in U.S. politics.
Here is the silver lining in the clouds looming over Wall Street:
some of the regressive social engineering that took place over the last decade is about to
come undone. Certainly the extension of these counter-reforms, in the form of privatizing
Social Security, has been dealt a serious blow. The more class-conscious among the
privatizers, such as Washington Post columnist James Glassman, have been fully
cognizant of the political implications of replacing social insurance–which is not only
many times more efficient than any private alternative, but also a solidaristic system
with a different ethic–with millions of individual stock holders. They want people to
identify with corporate profits, and to have policy makers increasingly constrained from
doing anything that might upset the stock market.
The spread of stock ownership to 43 percent of households, many
through 401 (k) and other retirement accounts, has coincided with a record run-up in stock
prices. To be sure, this ownership is still highly concentrated, with the median household
holding only about $14,000 in stocks. In fact, 86 percent of the stock market gains since
1989 have accrued to the top 10 percent of households.
But the idea has been popularized that stocks are the means by which
the majority of people partake in the gains from economic growth. That idea will soon be
as good as dead. A more sensible alternative can be found in the not-too-distant past,
when the majority of Americans shared in the fruits of technological progress through
rising wages and an expanding social safety net: e.g. Social Security (which was indexed
to inflation in the 1970s), and expanded access to health care (Medicare and Medicaid,
long overdue to be extended to the rest of the population). If progressives are able to
frame the issue this way, they will likely find a receptive audience, now that the
alternative of gambling one’s life savings in the stock market has been exposed for what
Globalization in Crisis
Neoliberalism at the global level has also
been dealt some serious blows–although one of the hardest punches has not received the
attention it deserves: Russia’s default on $200 billion worth of debt, some $40 billion of
which is owed to foreigners. Like the proverbial sewer smell arising in the midst of a
dinner party, the guests–the international creditors–do not want to mention it. This is
a first for the international system of debt peonage, and the idea could easily spread.
Mozambique, one of the poorest countries in the world, is paying about a quarter of its
export earnings for debt service, more than it spends on education and health care. Other
desperately poor countries are similarly squeezed, and the threat of Russia’s example is
being taken very seriously.
The collapse of the ruble also has implications far beyond Russia’s
borders. The stabilization of the ruble had been the IMF’s only accomplishment over the
past six years. The ruble’s collapse just weeks after the IMF had put up nearly $5 billion
dollars to support it, which went right into the outstretched hands of speculators, has
given the Fund another high profile black eye. The IMF’s credibility crisis is
internationally the most important aspect of neoliberalism’s troubles right now, since the
IMF is by far the most powerful instrument of transnational capital. Since the Fund
inflicts more damage, in economic and human terms, than any other national or
international institution, it is worth looking at the current fight over expanding the IMF
in the context of the current international economic situation.
The spread of financial and economic turmoil has reminded people
that unregulated markets are prone to crises, panics, overshooting, recessions and even
depressions. At the level of the nation-state, a number of institutions have evolved which
regulate, and sometimes prevent the worst excesses and irrationalities of a market system:
even in the United States we have the Federal Reserve as a lender of last resort, Federal
deposit insurance, and the automatic stabilizers of government spending, to name just a
few examples. At the same time, and sometimes within the same institutions, the welfare
state has softened the impact of these irrationalities and also mitigated the injustices
that result from market outcomes.
The global economy has no analogous institutions, and transnational
capital and its political allies have deliberately expanded its importance (through
agreements like NAFTA, the GATT, and the MAI) for the purpose of avoiding the civilizing
influences of the last century and a half of struggle. The process has been one of
continually removing economic decision making from Parliaments, Congresses, and elected
officials, and placing it in the hands of unaccountable institutions such as the IMF, WTO,
For those who care about the human consequences of these
developments, there is a strategic question that is becoming increasingly important:
should we accede to the process of increasing global economic integration, and try to
create the requisite quasi-state institutions at the international level? Or should we
oppose it, with the hope that individual nation states will thus be able, to varying
degrees, find their own regulatory mechanisms–whether they be national-developmentalist,
social democratic, or even socialist?
In some cases it might be possible to do both–e.g., oppose the
process and simultaneously fight for labor rights clauses in new international agreements.
But in other cases our choices are much more limited, and it is crucial that we understand
this limited range of choice.
The IMF is one such case, and the lack of clarity among the
progressive community is hurting us. The recent troubles have amplified the voices of
those among our elite who would support some greater international regulatory
mechanisms–the U.S. Treasury Department calls it a "new architecture of the global
economy." While not all of the measures they would consider are harmful, the
expansion of the IMF’s power that they propose would be an enormous step backward.
Many people who would ordinarily oppose economic colonialism are
willing to acquiesce to, or even support the expansion of the IMF in the hope that it may
someday be transformed into its opposite. This is a terrible mistake. The IMF is a brutal,
colonial institution, controlled by Washington, an organizer of creditors that squeezes
the world’s poorest countries for debt service on loans they cannot ever hope to repay. It
is also a de-regulatory institution, whose adopted mission is to open up the world’s
economies to transnational capital on the latter’s terms. It has consistently wielded its
enormous power against any industrial or even agricultural strategy that has been centered
around national economic development. With the exception of the Mexican peso crisis, it
has never functioned as a lender of last resort, as its recent failures in Indonesia and
Russia have amply demonstrated.
This is not a question of reform versus abolition, as it is often
posed. The IMF will indeed change its policies in response to criticism–as even dictators
like Suharto did. In fact, it already has, allowing Indonesia to increase its budget
deficit target from 1 percent to 8.5 percent of GDP. But it will not be reformed into
anything that can have a net positive impact, if for no other reason than it is
unaccountable to any population anywhere. And it will not be abolished any time soon.
The idea that we can create international institutions, controlled
by the governments of the world’s richest countries, that would somehow reverse the
policies that these governments are pursuing, has always seemed far-fetched to me. It
would make more sense to first change the foreign economic policy of the United States,
where at least we can vote, before expanding its power over the poorer countries of the
The need for clarity on these questions is important, as the Clinton
administration is asking for $18.5 billion to expand the IMF’s capital base by 45 percent
(with the contributions of other members, who will likely follow the U.S. lead). With
every tremor in the international economy, as well as the stock market, the Administration
has exhorted Congress to approve the money or risk being blamed for the next disaster.
Most Democrats have gone along from the beginning, with only a handful–along with the
large majority of Republicans–holding it up. After the latest IMF-sponsored fiasco in
Russia, House Appropriations chair Bob Livingston, the Administration’s key Republican
ally, announced he was reconsidering his support, and Newt Gingrich made similar noises.
Neoliberalism will of course survive with a much weakened and
discredited IMF, but its backers are aware how much more difficult it is to force
countries like South Korea to accept mass layoffs or remove its remaining controls on
foreign capital and ownership, as the IMF has recently arranged, if the orders were coming
directly from Washington or a handful of private foreign banks. The neoliberals understand
the importance of this battle; unfortunately, many on our side do not.
Cracks in the Wall
It is understandable that many people could be
carried away by the prospect of global economic reform. There has been a significant shift
in the public debate over the last year, and even the last few months. A number of
prominent, pro-globalization, mainstream economists have come out in favor of increased
capital controls. Joseph Stiglitz, chief economist of the World Bank and former chair of
President Clinton’s Council of Economic Advisors, breached protocol by openly accusing the
IMF of exacerbating the Asian financial crisis. Columbia University’s Jagdish Bhagwhati,
one of the world’s most prominent international economists and the Economic Policy Adviser
to the Director-General of GATT (1991-93), has noted that "the Asian crisis cannot be
separated from the excessive borrowings of foreign short-term capital as Asian economies
loosened up their capital account controls and enabled their banks and firms to borrow
abroad. . . it has become apparent that crises attendant on capital mobility cannot be
ignored." Jeffrey Sachs and Steve Radelet of the Harvard Institute of International
Development have reached similar conclusions in some well-researched papers on the Asian
financial crisis, and Sachs has had some harsh words for the IMF, calling it "the
Typhoid Mary of emerging markets, spreading recessions in country after country." The
most radical break with neoclassical orthodoxy has come from no less a champion of
globalization than Paul Krugman, who, writing in a recent article for Fortune
magazine, proposed a return to restrictions on the convertibility of currencies. The
latter policy was promptly adopted by Malaysia last week.
These epiphanies by prominent economists are long overdue, and
recent events have provided an opportunity to blurt out the obvious. China has notably
been the least affected by the Asian crisis, and certain reasons for its relative immunity
seem clear: their currency is not convertible, they have little foreign ownership in
financial markets, and their banking system is government-owned. Being free from IMF
orthodoxy has its advantages: in response to the crisis, China announced last March a
three year, $1 trillion public works program (the equivalent in the U.S., if you can
imagine it, would be more than $8.5 trillion). How much and how it is actually implemented
remains to be seen, but any expansionary policy makes a lot more sense than the
beggar-thy-neighbor process of trying to export your unemployment by means of an
undervalued currency–the latter is a zero-sum game.
Krugman’s policy of foreign exchange controls makes sense, too, and
Russia appears to be the next candidate for adopting it, unless the IMF can stop them.
Look at the alternative: Mexico is jacking up interest rates to 38 percent in order to
stem the capital flight, currency collapse, resultant inflation, and possible economic
disaster that has threatened them because of…Russia–country that has nothing to do
with them. The irrationality of international financial markets has reached new extremes,
as one poor country after another is trampled by the herd behavior of investors who may
know nothing more than the fact that other investors might be averse to "emerging
markets" after the last disaster.
The human cost of this irrationality has been staggering, especially
in Asia. Years of economic and social progress are being negated, as the unemployed vie
for jobs in sweatshops that they would have previously rejected, and the rural poor
subsist on leaves, bark, and insects. In Indonesia, the majority of families now have a
monthly income less than the amount that they would need to buy a subsistence quantity of
rice, and nearly 100 million people–half the population–are being pushed below the
poverty line. Women have been particularly hard hit: they are first to be laid off, have
taken sharper cuts in access to food and other necessities, and girls are being pulled
from school to help with their families’ survival.
How much of this misery is directly due to neoliberal policies and
their supporting institutions? It appears to be quite a bit. The short-term debt build-up
that preceded the Asian financial crisis clearly created the instability that turned the
fall of the Thai baht in July 1997 into a regional financial meltdown. This rapid
accumulation of short-term debt, in turn, was a direct result of the removal of capital
controls–at the insistence of the United States. For example, South Korean, Thai, and
Indonesian banks (as well as non-financial corporations) were allowed, in the last six
years, to borrow from international markets with fewer restrictions then ever before.
Since the burden of foreign debt service increases when the domestic currency falls, this
left these economies extremely vulnerable to a panic, and the ensuing vicious spiral of
What was needed at the onset of the crisis was a supply of foreign
exchange reserves to assure investors that they did not have to flee the country today in
order to avoid further foreign exchange losses tomorrow. The government of Japan actually
proposed, at a meeting of regional finance ministers in September 1997, that an Asian
Monetary Fund be created in order to provide liquidity to the faltering economies, and
with fewer of the conditions imposed by the IMF. This fund was to have been endowed with
as much as $100 billion in emergency resources, which would come not only from Japan, but
from China, Taiwan, Hong Kong, Singapore, and other countries, all of whom supported the
After strenuous opposition from the U.S. Treasury Department, which
insisted that the IMF must determine the conditions of any bailout before any other funds
were committed, the plan was dropped by November. It is impossible to tell how things
might have turned out differently, but it is certainly conceivable that not only the
depression, but even the worst of the currency collapses could have been avoided if the
fund had been assembled and deployed quickly at that time.
The IMF then failed to provide the necessary reserves–Indonesia had
received only $3 billion by March 1998. Even worse, the IMF’s insistence on very high
interest rates, as well as fiscal austerity, worsened the contraction of the injured
economies. The result was that a liquidity crisis, which could have been managed and
limited to the financial sphere of the economy, became a major regional depression.
Less noticed has been Washington’s contribution to Russia’s economic
disaster. Most Americans are unaware of it, but the Russian economy had already collapsed
long before the recent unhinging of the ruble and default on government debt. Over the
last six years, American economists–together with the International Monetary Fund–have
presided over one of the worst economic declines in modern history.
Russian output has declined by more than 40 percent since 1992–a
catastrophe worse than our own Great Depression. Millions of workers are not being paid
and most economic transactions now take place through barter. The majority of the
population has fallen into poverty. Death rates have risen sharply and the decline in male
life expectancy–from a pre-reform 65.5 years to 57 years today–is unprecedented in
peacetime, in the absence of a natural disaster. All of this happened before the current
The failures of neoliberalism are getting harder to ignore, even for
its defenders. Its global component had already suffered a significant defeat last year,
as the president’s quest for fast-track authority–to negotiate new trade and commercial
agreements without amendments from Congress–was blocked. Opposition to IMF expansion has
also thrown a wrench in their machinery. The Multilateral Agreement on Investment, a
treaty that would extend the investment provisions of NAFTA to the 29 mostly high-income
countries of the OECD (Organization for Economic Co-operation and Development), and then
to the rest of the world, has also been slowed down by worldwide opposition.
Nonetheless we are only beginning to crack the structure of
neoliberal ideology in the United States. Although the debate within the economics
profession has received a bit of coverage in the Wall Street Journal and the New
York Times, most reporting–whether through print or electronic media–remains
unaffected by it. The airwaves are saturated with blather about "crony
capitalism" as the cause of Asia’s troubles, and we are daily reminded that Russia
needs to be forced to follow the West’s "reform" program more diligently. Unlike
the stock market, which directly affects some millions of people’s lives and forces them
to think about their future, foreign economic policy remains in the mystified realm of the
experts and officials. The foreign policy establishment has made no concessions, and is
not planning to make any. The Clinton administration is forging ahead with plans to
complete the MAI negotiations this fall.
Washington is a still a long way from changing its course, but its
ability to impose its neoliberal dogma on the rest of the world is waning. And that, by
itself, is cause for hope.
Mark Weisbrot is Research Director at the Preamble Center, in
Washington, DC (www.preamble.org).