After Neoliberalism: Economic Theory and Policy in the Polycrisis

The concept of a ‘polycrisis’ has come to prominence in recent years as a way of highlighting the simultaneous emergence of deep and difficult-to-solve problems across the domains of geopolitics, economics, environment, technology and society. In the economic field the crisis can be dated to the 2008 financial crash, from which western economies have still not fully recovered. In the thirty years before the crash (from 1978 to 2007) per capita economic growth in the advanced economies of the G7 averaged 2.1 per cent, even including three recessionary years. After the crash, between 2010 and 2019 (before the Covid pandemic), it averaged 1.4 per cent a year. That's a fall in the core performance of the world's leading economies by one-third. In the US average real earnings were, astonishingly, about the same in 2018 as they had been in 1968.

What exactly is this a crisis of? It's not a crisis of capitalism, in the sense a Marxist would recognise. The system is not collapsing under the weight of its own contradictions. On the contrary, capitalists have been doing rather well. Since around 2000 the value of capital—assets—has grown much faster than GDP. Equities and debt have grown nearly twice as fast; real estate by a third more.

But if it isn't a crisis of western capitalism, it is surely a crisis of the promise held out by it: the promise of steadily rising living standards for the majority of the population. This is why some people have hailed the present moment as a crisis of neoliberalism—even its death knell. Neoliberalism, the economic ideology of deregulated markets and a smaller state, was promoted by Thatcher, Reagan and their followers as the means to make people better off. But it hasn't.

The crisis in economics

But this is more than just a crisis of economic policy. There have also been profound failures in the underlying economic theory.

Financial deregulation was based on the theory of efficient markets. But the financial crash proved it wrong. Austerity was based on a mainstream economic view of the relationship between debt and growth. But that was wrong too, as the IMF, its champion in 2010, had to admit in 2013. More recently, mainstream economists have had to accept a heterodox explanation pf the recent inflation, which was a product less of the conventional phenomenon of a ‘wage-price spiral’ than of companies with monopoly power raising their profit margins.

It matters that mainstream economic theory has been failing in these multiple ways. This is partly because successful policy making needs to rest on sound economic analysis. But it is also because economic theory plays a critical role in politics and policy making. The economic theory underpinning free market policies was the justificatory basis for the neoliberal project.

Justification plays a critical role in political discourse. Thatcher and Reagan got people to vote for the free-market agenda by harnessing simplified neoclassical economic theory. This was where Thatcher's famous 'household budget' rhetoric came from: the need for government to live within its means. It is why right-wing politicians claim that governments can't ‘pick winners’ through industrial policy; only the market can do that. It is the origin of the claim that higher corporation tax will lead to lower investment. All these nostrums derive from simplified neoclassical economic theory.

We therefore not only need new post-neoliberal policies and better economic analysis, but a new theoretical foundation to underpin them.

Institutions

Mainstream neoclassical economics is founded on what we might call ‘ontological individualism’. This is the view that the fundamental actors in economies are individuals and their households, and individual firms. These actors are sovereign, and it would be unethical and authoritarian to challenge their preferences.

But individuals and firms do not simply invent their preferences by themselves. They are the products of their social and institutional context.

As anthropologists and sociologists have long acknowledged – but mainstream economists have not – institutions are the fundamental building blocks of society and economy. Institutions can be defined as ‘the systems of established and prevalent social rules that structure interaction’. It is important to note that, while some institutions are organisations, some are not. Marriage, for example, is a social institution: a set of social rules that govern behaviour. Both incorporated and social institutions shape the value systems, preferences and motivations of individuals and firms.

Individuals and individual firms still matter. They have their own preference functions. How they behave determines overall outcomes—though not always in a simple ‘aggregate’ way. But the way they behave is not simply the result of their own autonomous choices. Those choices are constrained and shaped by the kinds of institutions they are, and the kinds of institutional context they find themselves in. In a different institutional context, they might—they very likely would—have a different preference function and behave differently.

Let us give a policy-relevant example of this. Over the last twenty years, in both the UK and US, elderly social care providers have increasingly been taken over by private equity firms. Economists in the US have compared the mortality of patients in nursing homes owned by private equity with those in homes in ordinary private ownership, controlling for all other factors. They found that going to a private equity-owned nursing home after an acute hospital stay increased mortality by 10 per cent against the overall average. This means that in a twelve-year period in the study sample, over 20,000 lives were lost owing to private equity ownership.

Why is this? It isn't perhaps a surprise to find that firms owned by private equity have lower care standards and make more profit. That is, in exactly the same situation, different kinds of institution behave differently.

‘Institutionism’ is the name we can give to the economic approach which starts from the premise that to understand the behaviour of the individual households and firms we need to understand the economic institutions in which they operate.[i]

Institutional pluralism

An important insight follows from the institutionist perspective: we need different kinds of institution for different spheres of life. Society functions best with institutions that are based on the values and motivations appropriate to the context.

Society is made up of different spheres of life. The family is one, with its own motivations and ethics; we don’t treat family members as if they were in a market. Another is the local community. Within their communities many people engage in voluntary and mutual activity, where the underlying ethic is an idea of the common good and human need. A third sphere of life is the public. Here, impartiality, fairness and professionalism are the key principles. In the sphere of commerce, by contrast, we acknowledge that competitive behaviour, profit and personal gain are legitimate and even good. In the natural world, we need human institutions which reflect and mimic natural systems.

The neoliberal project has wanted to extend market-like institutions, with market values and motivations, into more and more areas of society. Sectors which were once organised according to public sphere principles, such as the water industry and the Post Office/Royal Mail, have been turned into commercial sector operations, with evident losses of part of their purpose. A core conclusion of an institutionist view is that we need to create and sustain institutions whose value systems and motivations are appropriate for the context in which they operate.

The implications for policy

Institutionism is particularly relevant in the economics of policy making. The neoclassical, market-based view has been that policy should in most cases be based on trying to create markets and make them more efficient. Thus it was thought that private equity firms, with their powerful profit motive, would improve social care. Today an institutionist approach would recognise that it matters what kinds of institution run care homes. It would probably ban private equity ownership altogether and insist that all care home owners be small businesses and social enterprises.

Another example would be in climate change policy. The mainstream economic view is that global warming is an externality, so it should be internalised in the market in the form of carbon price, or tax. But most capitalist economies have now tried this, and found it very difficult to get it to work. Political institutions have mostly been unable to institute carbon taxes at a sufficiently high level to change economic behaviour enough. In practice renewable energy technologies have been successfully developed under emissions targets and regulatory mandates, not carbon prices.[ii]

How would an institutionist think about this problem? They'd want to design an institution which reflected the limits of the natural world. The climate problem is caused by our economies exceeding the safe level of greenhouse gas emissions. So we need an institutional framework which limits a country's total greenhouse gas emissions to the safe level. That is, in fact, precisely what we have in the UK. The 2008 Climate Change Act requires the government to set, by law, a set of ‘carbon budgets’ consistent with an emissions trajectory to net zero, and to produce policies and plans able to keep emissions within that limit. Its renewable energy mandates then do this. The Climate Change Act is an institution —a set of rules that structure economic interaction.

A third example of an institutionist approach would be in the field of business investment, which in the UK has been much lower than in comparable economies. This is a primary cause of our low productivity. The neoliberal policy solution is to give investment tax breaks. But there is no causal relationship between corporation tax and investment levels. The institutionist approach would be to ask whether we have the right institutions for investment. Is the model of the shareholder-owned business, where the shareholders are financial institutions mainly seeking a short-term return, the best one? State investment banks such as the German KfW, have much better records of investing in infrastructure, housing and business development in deprived regions than the land and property-focussed private banks of the UK. KfW is a different kind of institution from a commercial bank. It must by law invest in socially useful activities. It has specific mandates to invest in green infrastructure and in deprived regions of Germany. It is an institutional, not a market-based, solution.

Conclusion

In previous eras of crisis, worldviews have changed across the political spectrum. After the Great Depression and the Second World War, socialists, liberals and Tories alike became a Keynesian and a supporter of full employment and the welfare state. After the economic crises of the 1970s, almost everyone became a kind of neoliberal, accepting much of the Thatcherite settlement and the primacy of the market.

Today, we confront in the polycrisis a daunting array of policy challenges. In these circumstances we need to acknowledge that it is not just a new set of economic policies which is needed, but a whole new theoretical foundation for them. To achieve the necessary goals of a modern economy - environmental sustainability, a reduction in inequalities, wellbeing and resilience – we need to ask, not: how can we make a better market here? But: how can we build better institutions?

This article was originally given as the Political Quarterly annual lecture in November 2023. The author would like to thank Joni Lovenduski, Deborah Mabbett and Ben Jackson for helpful comments on the original lecture.