In defence of neoliberalism

The "neoliberal era" has not only made Britain rich, but has done more to reduce global poverty than any other time in history

BY Sam Bowman | s8mb   /  29 March 2017

We should judge economic systems by their results. When judging the much-maligned “neoliberal era” from the late 1970s to 2016, what matters is whether it made people’s lives better or not.

This era, I believe, has seen enormous progress in terms of wealth creation and improvements in the wellbeing of both Britain’s and the world’s poor. Opening markets up and exposing incumbent firms to competition led to a massive increase in wealth that ended up in the pockets of the many, not the few.

This system is now under threat from people who want to undo the reforms of this era from both the left and the right. Anybody who prefers prosperity and growth to stagnation must now make the preservation of the global liberal order their main priority.

The global picture

Everyone used to be poor. The default for mankind is poverty – the question isn’t why people are poor, but how anyone has become rich.

Before the industrial revolution, even the richest kings enjoyed a standard of living and a life expectancy below that of the average person in the West today. This began to change in the 19th and 20th Centuries, but improvements in people’s lives were concentrated in the Western world and Japan.

But, since the mid-1970s, that has begun to change. Global absolute poverty has been in free fall since the current era of globalisation began, and China and other developing countries began to adopt more trade- and market-friendly policies. Trade and market liberalisation seems to have been the major driving force behind this uplift in incomes and living standards.

The figure above shows global trade as a percentage of GDP since 1960 – that is, how much of what countries produced was meant for export, and how much was meant for domestic consumption. This very large rise demonstrates the growth of global trade during this period, and the deepening economic integration that took place across the world.


We can look at a whole range of measures based to their levels in 1990 to see whether this rise in global trade coincided with improvements in people’s living standards. The figure above, based on World Bank data, demonstrates substantial improvements in things like literacy, pollution control, and hunger reduction.

These lines on the screen represent real people, with real lives. Falling hunger means fewer children going to bed hungry, or growing up stunted because they’ve been so badly malnourished as children, or even dying of starvation or disease. If vitamin-fortified GM crops like Golden Rice could be bought and sold freely, things would be even better.

People who are no longer in extreme poverty still have grindingly difficult lives, but slight improvements in people’s incomes can still make them much better off. Recent evidence from Bangladesh shows that women and girls who lived in villages close enough to work in sweatshops instead of subsistence farming were able to marry later, delay childbirth, and were much more likely to stay in school for longer – effects that were all strongest in 12-18 year old girls.

The figure below shows how unusual the global poverty reductions since the 1970s are, by historical standards. For most of human history we’ve been in a Malthusian trap where only a lucky minority could live in anything more than absolute poverty. We’ve been living through an unprecedentedly good period in human history.

The largest driver of this effect, of course, was China. Beginning in 1978 with agricultural reforms that disbanded communal farms and permitted rural non-farm enterprises, through the decentralisation of control to the state-owned enterprises in the later 1980s, until the full invigoration of the private sector from 1992 with reforms to taxation, property rights, banking and foreign trade and investment, China’s growth has been truly remarkable. Whether the growth was primarily export-led or not is the subject of some debate, but trade was unquestionably a major driver of China’s growth – at least one third of its growth per annum.

Even if we exclude China from the global data, though, the share of people living in extreme poverty still fell from 29% in 1981 to 12% in 2013. Allowing people to move from subsistence farming into factory work has given them higher incomes and a chance to make a better life for their children, mirroring the move that Britain made in the 17th and 18th centuries, and other developed countries made in the 19th century. Countries like the USSR and Maoist China that have tried to strong-arm the switch towards industrialisation have had mass death, famine, and failure.

The global picture between 1988 and 2008 is represented in the figure below, with the horizontal x-axis representing different income percentiles and the vertical y-axis representing how much richer that percentile was at the end of the period compared to the beginning.

This “elephant chart”, originally published by economist Branko Milanovic and named for its supposedly elephant-like shape, showed very strong real-terms growth among the “global middle” and the people at the very top of the global income distribution, but relatively poor or even negative growth among people in the 70th to 95th percentiles (as well as people at the very bottom).

This, it was thought, told the story of Brexit, Trump and Le Pen: a dissatisfied Western working class that had been “left behind” by globalisation. Paul Krugman described it as showing “recent history in one chart”.

But all is not as it seems. Adam Corlett, an economist at the Resolution Foundation, realised that, in Britain at least, the national figures told a different story. Decomposing the data showed that many mature economies had experienced very strong growth – the UK in particular, where every income group experienced nearly 100% real-terms growth in disposable incomes. The bottom 10% saw their incomes rise by over 160%!

What Milanovic’s original chart concealed, Corlett found, was that population shrinkage in Japan and catastrophes in many post-Soviet economies were skewing the data. When those countries were removed from the data set, the world’s developed countries showed decent (if not stellar) growth of between 45% and 60% across the board in this period – with high variations, suggesting that there is nothing inevitable about stagnant incomes for the developed world’s lower middle classes.

The British case

Britain’s growth during this period has been remarkable. Not only have incomes doubled in real terms, the UK has done very well relative to its neighbours in continental Europe. The figure below shows the GDP per capita in the major European economies as a percentage of the USA’s. We use the US as a benchmark to represent the technological frontier – a proxy for the richest a large and diverse economy could be.

What we see is that, from around 1980 (marked by the red vertical line), the UK began to converge with the US and improve relative to Germany, France and Italy. (Note that the German numbers are distorted by including the former East Germany from 1991 onwards, making it less useful as a comparison after that.) This is likely to be a combination of the pro-market Thatcher reforms and the increased openness to trade and competition caused by EU membership. The opposite set of policies saw us fall from being the very richest country in Europe 1800-1950 to being mid-ranking by 1973.

This is useful to bear in mind when considering arguments like this one that the Thatcher reforms were a failure because trend growth after 1980 was slower in Britain than trend growth before 1980. If growth across the developed world happened along these lines, but Britain’s post-1980 growth was unusually strong relative to the others, then we have what looks like quite a strong case that Thatcherism and EU membership were good for Britain’s economy.

Income inequality (the figure above) did rise during this period, but only early on, and it has not risen since. Indeed the ONS recently showedthat income inequality was at its lowest level in thirty years.

Similarly, the wealth shares of the top 10%, top 5%, top 1% and so on have all stayed static since 1980 in Britain, and at historically low levels (the figure below). It should be noted that wealth shares had been falling for the century prior to this, and some may view the levelling-off of this trend as a bad thing, but it cannot be argued that the post-1980 reforms made this worseI doubt whether inequality is worth focusing on at all, as opposed to the absolute wellbeing of the poor, but in any case the data does not show a big problem here.

The British experience since the crisis has been unpleasant, but much less bad than most other countries. I suspect a large part of this is explainable by our having an independent central bank that eased policy substantially when it needed to (as the US Federal Reserve also did but, catastrophically, the European Central Bank did not), and the labour market reforms that weakened trade union power, making it easier to fire workers and cheaper to hire them.

It’s interesting that, since the crisis, the bottom 20% have done best compared to where they were in 2008. This is not to diminish the importance of raising their incomes more – they are still a lot poorer than the average UK household – but it points to a resilience in the British system that has shielded our worst-off households from economic harm in ways that other countries have had less success at doing.

What’s next

The evidence above does not prove that unregulated markets are always and everywhere a good thing. But it does tell us that the “neoliberal” era of rising international trade and domestic deregulation coincided with astonishing improvements in people’s wellbeing both in Britain and in the world’s poorest countries. Those who want to undo what has been achieved should face extreme scepticism by the rest of us.

The populists and nationalists who are gaining support in many Western countries are doing so after a period of low or zero median income growth since the Great Recession. Though their support falls along cultural lines, their rise cannot be held separately from economic factors.

Trade probably cannot be blamed for the bulk of the decline in manufacturing jobs, which some people hold to be uniquely important. Manufacturing jobs have declined for the most part because automation, not foreign workers, can do the same thing for less. One estimate is that 88 percent of job losses in US manufacturing are because of automation, not foreign competition.

Of course things could be better. But mostly those improvements will come by doing more opening-up of markets to competition, not by closing up competitive ones.

Take the use of land, for example. It’s not obvious to people that there are huge second-order effects that restrictions on land-use create.

These restrictions on what you can build do not just raise the cost of housing – they stop people from moving to where the jobs are, and hold back economic progress in general.

A computer programmer has fewer opportunities to get a high-productivity job or to meet someone she can create a brilliant new iPhone app with in Spokane, WA, than in Silicon Valley. But if San Fransisco rents are so high that she cannot afford to move to where the other programmers are, the wealth she might have created is just gone. In the UK, how many people would like to move to somewhere like London or Cambridge to find better-paid, more productive work – but are prevented by housing costs?

The cost of this effect across the economy can be enormous. Economists Chang-Tai Hseih and Enrico Moretti have estimated that restraints on building new homes in high productivity cities like New York and San Fransisco could be making the US 13.5% poorer than it needs to be, and simply reducing building regulations down to the level of the median US city could increase US GDP by 9.5%, permanently. Britain’s restraints may be even worse.

Here, as with trade, incumbents protected by regulation may be worse off if it is removed, at least in the short term. But the crucial point is that there is not a fixed amount of stuff to be made, or a fixed amount of houses to be allocated. In both cases, allowing new players to compete against incumbents does not just drive down prices, it allows for potentially much greater gains by reorganising what people do in a more efficient and innovative way. There are so many other parts of the economy where this is also the case – we focus on the “seen” winners and losers and forget the longer-run, unseen effects.

Summing up

The case for free markets is that they do a better job of creating wealth than anything else we’ve tried. It does not require us to believe in inviolable property rights or that taxation is theft, or indeed that government always and everywhere is a bad thing.

It does not even ask that we treat human beings’ interests as being roughly equal in importance. If we do, the case becomes a lot more urgent because the lives of the global poor matter to us as well as those of our countrymen. But the nationalistic, selfish case for free trade and free markets stands by itself.

The “neoliberal era” has made Britain rich and has made unprecedented steps forward in improving the lives of the world’s poor. Those people who now threaten to undo it should not just be opposed by free marketeers, but by anyone who wants tomorrow to be better than today.