The term ‘neoliberalism’ is commonly used pejoratively and as a catch all for the cause of the malaise that has beset advanced economies of the West. My book analyses systemic causes of current failures of governance and traces their origins to ideas developed by Milton Friedman. This article analyses the economic consequences of four revolutionary ideas of that neoliberal ‘influencer’ of the 1970s and 1980s:
- State funding of schools ought to be designed to enable all parents to have the opportunity to buy a better education for their children.
- Government’s macro-economic policies ought to be limited to controlling inflation by control of the money supply.
- Models can use probabilities to forecast future uncertain outcomes.
- The social responsibility of business is to increase its profits.
Baking Social Segregation into Chile’s System of State Education
Sebastian Edwards describes Milton Friedman’s first idea in The Chile Project: The Story of the Chicago Boys and the Downfall of Neoliberalism. Friedman’s voucher scheme for schools was designed to democratise parents’ ability to pay to a better education.
Traditionally, the only people able to choose a school were those who could afford to pay the full costs of private education (in addition to paying taxes for other children to go to state schools).
That scheme had other attractions when compared with traditional arrangements: state schools were under bureaucratic and political control by local governments; children were assigned to the local school’s catchment area, and parents had no choice; and schools’ budgets were determined by making incremental changes that did not take account of changes in the numbers of pupils.
Under Friedman’s voucher scheme:
- Parents would have free choice between competing schools.
- Schools would become self-governing.
- The funding of the school would be determined by ‘money following the pupil’.
- Each parent would have a voucher to use in choosing a school.
- Some schools would only require the voucher. Other schools would offer a better education for parents willing to add a ‘top-up’.
Chile’s voucher scheme exemplifies Albert Hirschman’s analysis of the interactions between Exit, Voice and Loyalty. ‘Top-up’ schools have more to spend and pupils who are easier to teach: Chang-Tai Hsieh and Miguel Urquiola found middle-class parents exited from voucher schools to top-up schools. They stay loyal to those schools because, if their quality were to falter, then they can use their powerful voice to put pressure on school heads and governors to improve.
The monetarist revolution was based on the quaint idea that a government’s macroeconomic policy ought to be limited to controlling the money supply as the means of controlling inflation.
Parents on low incomes, who cared about their children’s future, would struggle to enable their children to exit from voucher schools. So, those schools would tend to end up with children whose parents who were poor, did not care about their children’s education, and if they did, lacked voice powerful enough to put pressure on failing schools.
In Created Equal, Friedman condemned governments that implemented policies that aimed for equality of outcomes. He argued instead for the objective of equality of opportunity. John Rawls’ Theory of Justice explained that, because of inevitable differences in endowments of individuals, equality of opportunity is a chimera. Friedman’s voucher scheme was designed to produce inequalities of opportunity, Cristián Bellei, and Gonzalo Munoz show both have continued in Chile, despite student protests.
Setting a Post-War record for Unemployment Britain by Monetarism
When Friedman won the Nobel prize for economics in 1976, for his second idea, ‘monetarism’, the citation summarised his distinctive contribution as ‘only money matters’. The monetarist revolution was based on the quaint idea that a government’s macroeconomic policy ought to be limited to controlling the money supply as the means of controlling inflation.
Paul Krugman pointed out that the UK’s prime minister, Margaret Thatcher, ‘was surrounded by men who had been really convinced by Milton Friedman’: from 1979 to 1986, her government ‘did not announce policy goals for output, employment or inflation. It simply announced targets for a broad monetary aggregate’.
Friedman condemned governments that implemented policies that aimed for equality of outcomes.
The two vital missing pieces in the simplistic economic policy of monetarism are laid bare by Tim Lankester’s devastating account of having been Inside Thatcher’s Monetarism Experiment .
These were the lack of an operational definition of how the supply of money ought to be measured, and an effective system of control.
The Thatcher government’s drive to reduce inflation, coupled with bewildering failure to control the money supply, resulted passive acceptance of devastation of British manufacturing with these consequences:
- A post-war record for unemployment, which increased from 5.4% in 1980, to 11.8% in 1984, and did not return to 5.4% until 2000.
- Concentrating the return to prosperity in England’s golden triangle of London, Oxford and Cambridge.
- Creating the areas that have been left behind and voted for Brexit.
Financial Derivatives as a Cure to Stagnating Incomes?
In seeking answers to the question Has neoliberalism failed?, Samuel Gregg argued that one landmark success has been it is now imperative for governments to control inflation. And indeed, as the Financial Times reported, failure to do that is one explanation why, in 2024, in 10 major countries, for the first time in over a century, incumbent governments lost national elections.
But, as Raghuram Rajan argued, for successive neoliberal governments in the USA in the 1990s, their remedy to the stagnation in median incomes was enabling the poor to buy houses by financing sub-prime mortgages so they would feel better off when the prices of their houses increased.
In the USA, decisions on mortgages used to be made by professional loan officers who exercised independent judgements, taking into account the potential borrower’s financial position and standing in the community. Daniel Markovits describes how that changed to low-grade employees completing loan applications for Wall Street to repackage loans into complex derivatives.
In Radical Uncertainty, John Kay and Mervyn King explain that the risk-based models used to determine the value of derivatives, by valuing financial contracts with years to run, were based on Friedman’s third revolutionary idea. John Maynard Keynes and Frank Knight made the profound distinction between risk, which can be quantified and modelled, e.g., forecasting the likelihood of outcomes of throws of a dice; and future uncertainty, which cannot, e.g., when there will be the next global pandemic. Friedman’s third revolutionary idea is that we can ignore that distinction.
In 2007, Naseem Taleb’s The Black Swan argued that the risk-based models used by investment banks to value derivatives, underestimated the likelihood of extreme outcomes (‘black swans’). The astonishing degree to which they did so was revealed by David Viniar, the chief financial officer of Goldman Sachs. On 13 August 2007, as the global financial crisis began to bite, he claimed that they were seeing market outcomes each day that were 25 standard deviations from their mean prediction. Kay and King point out that there aren’t enough days in the history of our universe for an outcome with that daily probability to happen.
Are Shareholders the Only Stakeholders Who Ought to Matter?
Friedman described his fourth revolutionary idea, which was published in 1970, in the New York Times as a ‘fundamentally subversive doctrine’. He despaired of the then prevailing attitude of businessmen who declaimed ‘that business is not concerned “merely” with profit but also …takes seriously its responsibilities for providing employment, eliminating discrimination, avoiding pollution’. For Friedman, they were ‘preaching pure and unadulterated socialism’. Instead, he argued:
“there is one and only one social responsibility of business—to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud”.
- Marianna Mazzucato’s The Value of Everything explains how Friedman’s ‘fundamentally subversive doctrine’ for businessmen was developed into the objective of increasing shareholder value. Remuneration committees base their decisions on the pay and bonuses for their executives on increases in shareholder value and the size of the enterprise. So, they reward cost cutting, and financial engineering by buying back shares and mergers and acquisitions.
- Rana Foroohar and John Kay have described how cost cutting and financial engineering have resulted in the demise, in the USA, of General Motors, Hewlett Packard, Kodak, RCA, General Electric, Sear Roebuck, and Boeing; and, in the UK of ICI, GEC, and Marks and Spencer.
- Anna Minton points out two consequences of the drive by housebuilders to increase their profits. First, they limit the numbers of houses they build in an area, so as to keep prices high. Second, they ‘favour small luxury apartments in city centers that are sold “off plan” and marketed directly to foreign investors’.
- Tom Archer and Ian Cole estimated that, between 2005 and 2017, the largest UK housebuilding companies doubled profits per unit and increased dividend payments more than fourfold.
The slump in demand for new houses in the UK, after the Global Financial Crisis, would, in a world of perfect markets, result in suppliers reducing their prices. That did not happen. So, to stimulate demand, the UK government subsidised the prices paid by first-time buyers by its ‘Help to Buy’ scheme. This aimed to deliver ‘a great deal for homebuyers’ and ‘a great support for homebuilders’. As the Financial Times observed, it ‘certainly delivered on the second’. It financed 60 per cent of all Persimmon’s sales and did wonders for its share price.
The Financial Times reported, Persimmon’s bonus scheme was linked to increases in the price per share from £6.57; and, in 2018, its share price was £24. In 2017, Persimmon paid bonuses of over £400m to its executives and made Jeff Fairburn the UK’s highest paid chief executive.
The outrage sparked by these awards was heightened by the discovery that the houses that Persimmon had built were woefully deficient. The new chairman of the board commissioned an independent review into its culture, workmanship and customer care. The Financial Times set out the review’s damning findings in a leader:
It has laid bare a corporate culture driven by greed, one with a focus on buying as much land as possible and selling the houses it built as quickly as possible rather than on building quality homes. It lays bare a litany of failings, from a reliance on box-ticking to the absence of systems to inspect work in progress. Even worse, the company had a ‘nationwide problem of missing and/or incorrectly installed cavity barriers in its timber frame properties’ to help to prevent the spread of fire.
Given that the company has in the past 10 years achieved stellar stock market success, and in the process made Mr Fairburn and other executives extremely rich, it is doubly telling that careful independent scrutiny has found that it has no central purpose. The only purpose, it might be inferred, has been the creation of that wealth.
Keynes is one of the heroes of my book, and the title of this article is inspired by his The Economic Consequences of the Peace and The Economic Consequences of Mr. Churchill. His The general theory of interest, employment and money was about learning how to avoid the high rates of unemployment that devastated communities in the 1930s.
In that book, he famously observed ‘The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. …, it is ideas, not vested interests, which are dangerous for good or evil’. This article has tried to show how dangerous Milton Friedman’s ideas have been.
