The end of the neo-liberal order?

With a new consensus in Washington, it’s time for Canberra  to consider a shake-up of misguided industrial policy.

US industry incentives have the potential to drain scarce capital and expertise away from Australia 

STEPHEN GRENVILLE

Published 13 Jun 2023

Did US National Security Advisor Jake Sullivan’s “New Washington Consensus” speech on 27 April signal the end of the neo-liberal order, when free markets had a paramount role in an economy dominated by private-sector enterprise?

Gary Gerstle’s book, The Rise and Fall of the Neo-liberal Order, provides useful perspective to the Sullivan speech. It fits America’s modern economic history into two “orders”: the New Deal Order, beginning with the Depression and ending with the stagflation of the 1970s; and the Neo-liberal Order, beginning with the election of Margaret Thatcher and Ronald Reagan and perhaps ending with the global financial crisis (GFC) in 2008.

The New Deal Order began in an economy with a tiny role for government – the top rate for income tax was 7%. The architect of the New Deal, Franklin D. Roosevelt, was an economic activist but on a small scale. The US government’s role was supercharged by the Second World War and came to maturity in the three post-war decades. Roosevelt was a pragmatist without a clear economic doctrine: Keynesian macro-management came later, and with it a burgeoning role for governments in the provision of social services (education, health) and infrastructure.

The 1970s’ stagflation discredited macro-economic policies. There was also disenchantment with the demonstrated deficiencies of government services and enterprises.
International trade openness is an important marker distinguishing economic regimes – putting autarchic Cuba and North Korea in a different category from America or Australia.

Thus began Gerstle’s Neo-liberal Order, backed by the powerful rhetoric of libertarians such as Milton Friedman. The coincident election of Thatcher and Reagan looked like a watershed order-changing moment.

Meanwhile, academic theory promoted the “efficient markets” hypothesis: free markets would provide optimal guidance for production and output.

This era brought productivity-boosting economic reform. But it also brought income inequality and industrial decline for Western economies as China became “manufacturer to the world”.

The 2008 GFC should have dealt a heavy blow to the “efficient markets” view, especially in its heartland – the financial sector. However, neither the GFC nor the limp recovery afterwards changed much. There was dissatisfaction (see “Occupy Wall Street”), but as no viable alternative was on offer, not much changed.

This near-century period looks like evolution rather than libertarian revolution. The continuities are more obvious than any epoch-defining breaks.

Throughout, markets continued their central role in allocation, while at the same time regulation increased, reflecting technology and complexity. As living standards rose, demand expanded for the kind of services that only governments will provide.

How does all this fit with Sullivan’s New Washington Consensus? Viewed in the context of the huge changes encompassed in Gerstle’s two “orders”, Sullivan’s economic changes are just a tiny tweak. Sullivan is belatedly putting rhetorical flesh around the already-announced policies in the Inflation Reduction Act, the CHIPS and Science Act and the Infrastructure Investment and Jobs Act.

We should note that John Williamson’s original Washington Consensus was a middle-of-the-road common-sense articulation of the indisputable advantages of markets and international trade, rather than libertarian dogma. Sullivan’s economic initiatives would easily fit within the old consensus.
Subsidies to offset the market’s inability to address climate change are advocated almost universally.

International trade openness is an important marker distinguishing economic regimes – putting autarchic Cuba and North Korea in a different category from America or Australia. But openness is one of the continuities in American policy: free trade was consistently and loudly advocated, even if never perfectly implemented. The liberal side of politics – the Democrats – was always ambivalent about the benefits of free trade. Sullivan’s interventions are well within the quite flexible parameters that characterise the norms of trade openness – and America’s past trade restrictions.

On tariffs, Sullivan says that the intention is to put “high walls around a small yard”. Compare this with Europe’s pervasive agricultural protection, so deeply embedded that it goes without comment. On industrial policies (subsidies and trade protection), major countries routinely give domestic-production preference in defence procurement – just one example of the pervasiveness of industrial policy. Post-Second World War America has always had large government projects and industry subsidies: Eisenhower’s highways; Kennedy’s man-on-the-moon; US Department of Defence (DARPA) technology subsidies, Tesla’s electric cars and Solyndra’s (failed) solar panels.

Subsidies to offset the market’s inability to address climate change are advocated almost universally. Active labour-market programs to address income inequality and soften industrial transition are found in many countries and have long been advocated for America.

In short, Sullivan’s New Washington Order falls well within the economic mainstream.

The element that makes the Sullivan speech seem of greater import is the unambiguous priority of security over these widely-accepted economic norms. US Treasury Secretary Janet Yellen’s speech earlier in April carried the same message.

We don’t have an analytical framework to weigh the supposed security advantages against the economic costs. Commentators have noted the doubtful security benefits. Here, we concentrate just on the economic costs – to America, and to its trade-partner allies.
Redirecting our current misguided industrial policies, notably domestic production of nuclear-powered submarines, would be a big step towards economic efficiency.

America, as a huge, resource-rich flexible and diverse economy, pays only a small efficiency cost for these interventions. The main distortions will be in the response of smaller less-diverse economies.

“The strong do what they can and the weak suffer what they must”. How should Australia react? As a beneficiary and active proponent of multilateral open trade, Australia has been guided by the idea that, just because your trading partners put rocks in their harbours, that doesn’t mean you should also do so. In any case, we don’t produce the high-tech products that are Sullivan’s focus. So, there are no trade policy implications for us.

US President Joe Biden’s climate-change initiatives, however, fall squarely into Australia’s comparative advantage: Australia’s has great potential to be a major global force in solar/wind-based electricity industries. Is America “eating our lunch”?

The climate challenge is so large that there is room for both countries (and others as well). The issue, however, is that Biden’s incentives may artificially suck scarce capital and expertise away from Australia.

We should overcome our usual well-founded presumption against industrial policy. This is the exception to the rule: a legitimate “second-best” argument for matching the incentives provided by the Biden initiative, at least in those aspects where we have clear comparative advantage – industries that require cheap, plentiful electricity, such as green hydrogen. 

Redirecting our current misguided industrial policies, notably domestic production of nuclear-powered submarines, would be a big step towards economic efficiency and enhance our energy security at the same time.