Winner of the New Statesman SPERI Prize in Political Economy 2016

Thursday, 25 January 2018

The fatal inconsistency within neoliberalism

The collapse of Carillion had some important implications for public sector outsourcing, as I discussed here, but I tend to agree with Will Hutton that the real lessons lie elsewhere. He writes
“While some public sector delivery is outstanding, notably in parts of the NHS, the general pattern is more patchy. It is for this reason that governments for decades have been contracting the private sector to deliver goods and services. Trying to extend that principle is not unreasonable if high-quality private sector partners step up to the mark: the problem is they are in such short supply.”

In other words the problem is not so much with outsourcing, if sensibly done by a government that does not automatically think private is best and a civil services able to write good contracts and effectively monitor quality. The problem is with the poor quality of so much British capitalism. Carillion is not just one bad apple, of course: this is a lesson that should have been learned from the financial crisis, and RBS in particular,

But how can that be, when the market ensures that only the most efficient firms survive? That idea, that the market ensures that only the most efficient prosper, is a central message of neoliberal ideology, and it has held UK and US governments under its sway since the time of Thatcher and Reagan. But that ideology contains a large and deep internal contradiction, which applies particularly to large firms like Carillion. To see what that contraction is, we need to talk about ordoliberalism and Ronald Coase.

Ordoliberalism is widely known as the German version of neoliberalism. It too celebrates the benefits of the market. It, like neoliberalism, ignores many of the failures of markets that Colin Crouch eloquently outlines and which economists spend a lot of time studying. But ordoliberalism does recognise one potential problem with their market ideal which neoliberalism ignores, and that is monopoly. Crouch makes a similar distinction in talking about market-neoliberals and corporate-neoliberals.

This distinction is important for reasons that go way beyond the textbook problem with monopoly: that prices are too high and output is too low. To see why it goes beyond that we need to turn to Ronald Coase. He was a British economist who subsequently worked at Chicago. His first major article was "The Nature of the Firm" written in 1937 which introduced the concept of transaction costs to explain the nature and limits of firms. The key point that Coase made relevant for our discussion is that, in theory, much of what firms do could instead be done by markets. For a non-economist this probably sounds strange, so I will briefly try and explain the idea.

In principle the activities of any firm could be duplicated by all its employees, including managers, becoming self employed. The worker who worked for a firm would become a self employed person who signed a contract with the self-employed manager. Furthermore, the self employed manager would not have to work with a fixed set of self employed workers, but for each task they could create a market for the task which any self employed person could bid to fulfil.

Coase asked why we have firms rather than this more market based setup. His answer is transactions costs. A typical worker employed in a firm has to do whatever (within reason) a manager asks them to do. This can vary, often at very short notice, depending on the needs of the firm. Replacing this with a large number of specific short term contracts would be very inefficient, because it takes time to write and read contracts (transactions costs). You could add search costs and many other costs that make the self employed contracting model normally inefficient.

You can see exactly these tensions, between the advantage of the market versus internalising activities within a firm, played out when a firm decides to outsource any of its activities. But these tensions have a darker side. To what extent have firms internalised the market so that they can exploit customers (traditional monopoly), exploit workers (if one large firm is the only potential employer for many workers i.e. monopsony), or as a vehicle for managers to exploit shareholders.

There are two paths you can travel once you recognise all this. The first, and more ordoliberal, is to distrust monopoly of any kind, and be highly skeptical of large firms and their creation through mergers. The second is to assume that firms are always right, and that large firms exist simply because they are more efficient at doing what they do than the same firm broken up. Given the darker side mentioned above, there is no logical reason to take the second path. Skepticism about large firms is the right path to take. The second path, where you presume that there are always good reasons why large firms exist, makes no logical sense, unless your goal is for whatever reason to defend these large firms. It is the path that neoliberalism took.

Will Davies has a fascinating paper of how ideas about the virtues of competition, and the need to break up monopolies, changed within the University of Chicago from the 1930s until the 1980s under the influence, among others, of the work of Ronald Coase. It shows how many of the leading actors during that period chose the second path. Economics is rich enough that, if they so wish, an economist can always invent reasons why monopolies might be efficient, and so earn lucrative fees for so doing.

Thus neoliberalism that might have started as extolling the virtues of the market ends up as “a consultancy racket, in which corporations purchase complex models to justify their chosen strategy”, to quote Will Davies more recently. This is what I meant when I wrote back in 2016.
“It is important that those who use the term neoliberalism today recognise this contradiction. It does not mean that using the term neoliberalism to describe the dominant ideology is wrong, but it is a mistake to assume the ideology has not be moulded/adapted/distorted by those in whose interest it works. These changes have made it intellectually weak at the same time as making it politically strong.”

There are important mistakes that those opposing neoliberalism can make if they do not see this point. They involve opposing anything your opponent appears to favour. Thus, for example, because neoliberals preach the virtues of the market but in practice are normally simply pro-business, this does not mean that you should always oppose markets: you can be pro-market and anti-neoliberal. More generally, just because neoliberals can use ideas from economics to argue their case does not mean there is something wrong with economics (as opposed to some economists). Louis Zingales, from Chicago, exemplifies both points, and is not afraid to make the distinction between pro-market and pro-business in public.

This is all related to the distinction between ideas and interests. While it is right to recognise that interests are to some extent based on ideas, it is also important to see that ideas can change in time to reflect interests. How an ideology based on seeing markets through rose colored spectacles turned into an ideology justifying crony capitalism is at least part of the story of neoliberalism. These compromises with power allowed the ideology to become dominant, but at the same time it also made it rather easy for it to be subverted by different kinds of plutocracies, such as those represented by Brexit and Trump.


  1. Whether we are on the left or right, we should also heed Coase's warnings about the the economics profession:

    "The degree to which economics is isolated from the ordinary business of life is extraordinary and unfortunate..... a time when the modern economy is becoming increasingly institutions-intensive, the reduction of economics to price theory is troubling is suicidal for the field to slide into a hard science of choice, ignoring the influences of society, history, culture, and politics on the working of the economy.....But knowledge will come only if economics can be reoriented to the study of man as he is and the economic system as it actually exists."


  2. I wholly agree with you here. Many businesses say they want competition and extol the virtues of size but these are just weasel words to cover their own interest.

    The last thing most businesses want is competition, simply because the opposition may win and they will then be out of business, so monopoly is a perfectly reasonable stance to aim for for the quiet life. People like Rupert Murdoch are always going on about how they welcome competition but their actions always belie their words because what they actually want is monopoly.

    Far too much of what passes for capitalism these days consists in a desire to confuse and then to exploit rather than improve; a better product or service seems to be too much to ask.

  3. Sorry, catching up on last few posts, where you have mentioned transaction costs.
    In UK gov, esp tech outsourcing, a major original reason, back in 1980s and still true today, was access to skilled (tech) resources. Gov IT is complex, becoming more so, now that systems are being joined up, and exposed in the web. Gov needs world class skills, but can't afford world class salaries, and often can't utilise world class resources full time.
    More critically, in IT, but probably also in other disciplines, Gov loses knowledge of its own systems. Only the outsourcers know the detail of how complex systems and processes work, including all the myriad workarounds.
    When it comes time to rebid a service, the incumbent, after 5/10 years understands the risks and costs, but also the real opportunities, rather better than any competitor. How that plays out in the bidding process is complex, in itself.
    But, my main point, when a new supplier takes over, even tho the staff with detailed knowledge may be TUPEed over, the new management will not understand the risks and opportunities for many months, even years. In many tech contracts, staff are largely self employed, hybrid Coase, and may not transfer. This learning curve is a massive transactional cost, resulting in a (temporary) drop in quality, and quantitative service levels.

  4. I think there are more issues with Coase's thought experiment than just 'transaction costs'. One of the characteristics of any system is that the optimisation of the whole system is not the same of the optimisation of its individual components. Hence the need for managers in the first place although I have met plenty of managers who are completely unaware of this point. The more you encourage people to look at things entirely from their own point of view the harder it is to encourage teamwork.

    You can also scale this point up and say that individual markets can be as efficient as you like but a society which emphasises the efficiency of these markets has not necessarily in any way optimised itself as a whole. This is not an 'ideological' point but one of pure logic and it applies to any system whether human society or machine.

    The other point I would make is that there is a world of difference between being 'pro-business' and just pandering to business all the time. It is like being 'pro-child' by giving way to your child's demands constantly. The result is not pretty and not necessarily very good for your child.

  5. Is it necessary to take one path, or another? Specifically breaking up certain firms can create substantial inefficiencies that could be bad for the consumer. One example is the situation produced by patent laws. An advanced technological product like a smartphone requires many individual components, each of which might become owned by someone seeking to take advantage. It makes sense for technological manufacturers therefore to conspire to control all parts of the component pipeline, and the very expensive and tortuous litigation thus avoided does not seem to be the advantage of anyone in particular.

    One other point I wonder about is distributional services for media. For example, media companies offering subscription services where for a certain amount of money per month consumers can obtain a range of media. If these companies were broken up, that would mean users would have to maintain separate subscriptions to a range of different services to get what they want to watch. But those companies are certainly close to monopolies - does the conventional logic about exploitation apply?

  6. Anecdotal experience again, outsourcing loses control, the company outsourcing loses all the aspects of carrying out the work, that is skills necessary to do the work, control over prices paid for materials and accessing the best quality, finally once you lose expertise in doing something you become prey to the so called experts that can rip you off. Again theory is a wonderful thing but you only know from practice what really needs to done. Development is also at risk, because the company loses insight of the technical aspect of doing something.

    Neo-Liberalism has produced the collapse in our manufacturing base and companies no matter how efficient they actually become, workers still lose out because they demand a proportionate share of the profits in working conditions and wages, which can be found to be cheaper in the far east than here.

    I have seen a myriad of so called world standard practices that would take companies to the peak of competitiveness, only to find nothing of the sort. Chairman ordinary people referred to as Clones, came and went all singing the same tune, instituting one daft idea after the other, then falling back on the old American standard, of when the company fails to achieve the target profit level, downsize the workforce to pay for it.

    Neo-Liberalism is dead in the water, there is no such thing as good Neo-Liberalism wherever you look for it, no matter what excuse you dream up, it's a dead duck and it's killing the world economy, that is currently surviving on personal debt, once again getting to breaking point.

    Socialism works, capitalism doesn't and for obvious reasons, but just in case people can't see it, I am not advocating Cooperatives but the Mondragon Coop is a window on human endeavour can work for humanity, better than any capitalist system, far more efficiently and rewards it workers to higher standard as well.

    This cooperative says itself it does not have all the answers, but compared to the private competition it is leading the world on how to humanise production with people running it on behalf of people.

  7. I say if you are pro-market, you already share so many assumptions (rational expectations, neutrality of money, GDP growth is good in and of itself to name three) with neoliberalism that the distinction you are drawing is trivial. You already believe markets are efficient and prices reflect value. For me, like an octoroon, if you share your core assumptions with neoliberals, you are one.

  8. One of the things that drives me crazy is (neo-liberal) politicians and representatives of 'the City' talking about the need for 'pro-business' policies.

    What they mean is 'pro-BIG-business' which is not the same as 'pro-business' and certainly not necessarily in the interest of the rest of society.

    The misbehaviour of big-business is a big deal. I am making an assumption with the following because I don't know the data (economics is not my field) but I'm pretty confident - I presume someone can tell me who has looked at this.

    One of the leading causes of small business failure is cash-flow (or rather lack of). I.e. businesses that are technically profitable run out of money. It is rife that big-business will not pay smaller subcontractors on time. Knowing that there is no real mechanism for small-business to enforce it. Knowing that the smaller company needs the larger far more than the other way round. Hence monopolies presumably are a major cause of otherwise viable small-businesses failing. That's not market forces, that's clearly a market distortion.

    The interests of big and small businesses are often not the same. Now, I am told that SMEs are the backbone of our economy, so why isn't the government interested in protecting SMEs from this kind of abuse by large companies?

    I know, it's a rhetorical question, really.


  9. I would add, as an MBA student at the University of Michigan, we were not taught that you just subcontract out everything as a manager of a firm, as neoliberals advocate for government. We were taught that there were very important cons as well as pros, and you only do it if the pros outweigh those cons. The cons included possible very high costs to monitor, control, and contract with outside subcontractors, and to coordinate with them in complicated operations, but also the costs of the subcontractors gaining monopoly power over you, because you become dependent on them, and they get specific and unique expertise about your business that you don't have, or will lose over time.

  10. Neat point about ideas and interests and their convergence over time. But when you say that "ideas can change in time to reflect interests." is that not misrepresenting reality ?

    Could you perhaps give examples of some major ideas that haven't converged to interests often over quite short timeframes ?

  11. Boeing did an experiment in contractual decomposition in their production of the 787. The aircraft was horribly delayed and only produced when Boeing stopped contracting things out and developing them internally. There are obvious areas of specialization - e.g. Boeing can't build its own jet engines - but there are levels of integration that work best without benefit of markets.

    Coase seems to have anticipated this.

    Neoliberalism is the perfect ideology for empty suits making money by manipulating symbols rather than producing things or providing services. Ownership is everything. Production is irrelevant. When we had a more managed capitalist system with extensive anti-trust, cross subsidies and industrial policy, we did better.

