With the current credit crisis that is sweeping our country and the world, the current global economy can seem to be an incomprehensibly complex system. However, by looking at the theoretical and ideological underpinnings of this system we can start to understand it, and the current crisis, much better. While it can be shown that much of our understanding of political economy today is dominated by Liberalism, that was not always the case. A look at how this theoretical understanding came to dominance will further help illuminate our current situation. Finally we'll see that while there are a variety of views on liberalism, those that embed liberalism within the oversight of government and it's surrounding society provide more convincing solutions for crises like the one we're currently facing.
One thing that the current credit crisis has done is exposed the ideological and theoretical underpinnings of the current global economic system. Recently the former Federal Reserve Chairman, Alan Greenspan, admitted to Congress that his ideology had pushed him to make flawed decisions. This is the ideology of Liberalism; of free markets, free trade, and spontaneous order of Adam Smith's pioneering works. It is an ideology based on the idea that less government is better and that markets, when left to their own, will create an efficient coordination of economic activities. Milton Friedman is one of the latter proponents of this ideology as he often described economic freedom as “an indispensable means toward the achievement of political freedom.”2 Alan Greenspan followed this ideology by letting the derivatives market remain remarkably unregulated and with little oversight from the government. It was under this same ideology that the sub-prime mortgage market was allowed to flourish without protection from malicious lenders or suspect mortgage bundling practices. The ideology of Liberalism maintains that a lack of government regulation was necessary to maintain an efficient market and sufficient to self-correct any irrational activity.
What makes this ideology so compelling is the theoretical structure on which it is based. This theory dictates the relentless use of the assumptions of “maximizing behavior, market equilibrium, and stable preferences”.3 These assumptions provide us with theorems which explain that a rise in prices will cause a decrease in demand and an increase in supply until an equilibrium is reached. In fact, this science of economics has been able to build a remarkably elegant and detailed theoretical framework based on these assumptions and theorems. Such is the appeal of the theories behind liberalism that “the degree of consensus on many issues among economists ... is little short of amazing.”4
These ideological and theoretical underpinnings of liberalism as the current economic model of choice are so strong in fact, that they are largely taken for granted. Even as Greenspan talked to many lawmakers about the current crisis, many Republicans tried to blame the mortgage meltdown on the unchecked growth of Fannie Mae and Freddie Mac and their government backing.1 For these lawmakers, the problem isn't too little government regulation, but too much government involvement in the market. This can be explained by the power of capital which has been theorized to create a historical bloc that is politically organized around a set of hegemonic ides that reinforce the basic tenets of capitalism.6 This means that these lawmakers are part of a government that is supported by a well-functioning market. The more efficient and productive this market is, the better support it can provide the government. This shows the symbiotic relationship between the state and the market as each has developed over time. Thus for some it becomes difficult to even think of questioning the current capitalist economy without questioning the government.
Looking at how this symbiosis between government and the dominance of liberalism has developed over time will help explain the actions that governments are now taking to address the current economic crisis. While Liberalism was most notably expounded in 1776 by Adam Smith it has since then faced challenges by several competing theories including Marxism and Realism. However, the theories of liberalism and the capitalist system they generated have proved to be very adaptive in the face of challenges. During the Industrial Revolution in England the ideals of liberalism were taken to their extremes leaving laborers incredibly downtrodden and miserable. But rather than rise up and overthrow the system as Marx predicted, the system adapted to become more accommodating to them with health and safety regulations. During the Great Depression of the 1930's in the United States the system again faced a crisis. Again liberalism adapted to provide relief for laborers in the form of the New Deal.
This adaptation in the face of social concerns took on an international aspect after World War II as America emerged the victor. It was at this time that agreements between Britain and the United States set the “terms for the reestablishment of an open world economy.”7 It was at this time that America was able impose the same form of liberalism that it had come to after the New Deal onto the global economy. The growth of capitalism based on the theories of liberalism were then only fettered by the emergence of communism in the USSR and related countries. When the Soviet Union fell it was further proof for many of the theories of free markets and free trade. Of course, by that time capitalism had shown itself to be able to adapt to a variety of countries and regions as Germany and Japan, for example, showed increasing growth.
In this historical context, it can be seen that the dominance of liberalism in our understanding of global economy has largely resulted because of the dominance of the states which have supported its existence and propagation. As these states became more powerful, either through culture, resources, geography, or policy, they work to instill their economic ideology and policy in states that come under their sphere of influence. This can be seen in the global economy with the concept of policy credibility which is “central to the broader task of elevating the market as the principal means of directing economic affairs.”8 This idea of policy credibility, which seeks to separate the state from the management of its money supply, though is not empirically supported. However, because it is the norm for the current dominant countries, it is pushed on to emerging economies as the solution for a better economy and state.
With the adaptability of liberalism and it's close relationship with the society and state with which it exists there is a strong argument that liberalism should be embedded within the social structure. Giving the market free reign can lead to an economic correction that is both painful and often sudden. We have seen that in the last few weeks in our current crisis. The understanding of the dangers of a purely capitalist society have been with us before, even recently, as George Soros has written, “the spread of market values into all areas of life is endangering our open and democratic society.”9 When a society is given a clear and understandable choice, they will always choose a stable and fair economic system. Equally offensive is the other side of the spectrum where the economy is completely subsumed by the state. Such systems, like those in the Soviet Union, cannot be as efficient as market-driven economies and will eventually fail or change.
That answer is embedded liberalism where liberalism is tempered by the society in which it develops. Since different countries and regions have different societies and different politics this is going to look different from country to country. While some may bemoan the inefficiency of so many different versions the overall effect is good. For even in our current global crisis there are several countries that will only be slightly affected. China, Brazil, and the UAE are just a few examples of countries that will continue to grow despite the current credit problems.10
What's more, even in the US, the amount that liberalism is embedded will change over time. As cultures and states become more or less risk-averse, their economies are likely to become less or more embedded, respectively. That is, now that we have experienced such a large shock to our system America will likely remain more risk-averse for a while. This will mean more government oversight and regulation to insure that any market corrections are small and manageable. A look at history though shows America to be a culture of risk-takers meaning that the pendulum will not likely remain on the deeply-embedded side for long.
While the current credit crisis in the United States is an immensely troubling concern, it has laid bare the the ideological and theoretical principles that have supported the current thinking on the global economy. This is giving economists, policy makers, and the public an unprecedented opportunity to recognize these underpinnings and question their usefulness. It will likely show that the current dominance of Liberalism on our theoretical understanding of the system is the result of historical events that favored America. It will also likely lead to a movement towards more of an embedded liberalism in which government and society have more oversight into the actions of the market. Thus even though the current crisis is troubling, we can look back at the amazing versatility and adaptability of liberalism in our past and be confident that it will continue to be a solid theoretical and ideological framework for understanding our future.
1. Andrews, Edmund L., “Greenspan Concedes Error on Regulation”, The New York Times, October 23, 2008, http://www.nytimes.com/2008/10/24/business/economy/24panel.html?ex=1240459200&en=3fafc8aefc36a9b7&ei=5087&excamp=GGBUgreenspantestimony&WT.srch=1&WT.mc_ev=click&WT.mc_id=BI-S-E-GG-NA-S-greenspan_testimony
2. Friedman, Milton, Capitalism and Freedom (Chicago: University of Chicago Press, 1962), Chapter 1, "The Relation Between Economic Freedom and Political Freedom," p. 7.
3. Becker, G. S. The Economic Approach to Human Behavior, (Chicago: University of Chicago Press, 1976), “The Economic Approach to Human Behavior,” p. 5.
4. Blinder, Alan S.
Blinder, Alan S. Hard Heads, Soft Hearts,
(New York: Addison-Wesley Publishing Company, Inc., 1987), �Murphy's
Law of Economic Policy,� p. 2.-->
4. Blinder, Alan S. Hard Heads, Soft Hearts, (New York: Addison-Wesley Publishing Company, Inc., 1987), “Murphy's Law of Economic Policy,” p. 2.
6. Gill, Stephen and Law, David, Gramsci, Historical Materialism and International Relations, (Cambridge: Press Syndicate of the University of Cambridge, 1993), “Global Hegemony and the Structural Power of Capital,” p. 94
7. Ikenberry, John G., International Organization, (The MIT Press, Winter, 1992) “A World Economy Restored: Expert Consensus and the Anglo-American Postwar Settlement,” p. 289
8. Grabel, Ilene, Monetary Orders, (New York: Cornell University, 2003), “Ideology, Power, and the Rise of Independent Monetary Institutions in Emerging Economies,” p. 25
9. Soros, George, Atlantic Monthly, Volume 279, No. 2, (February, 1997), “The Capitalist Threat”
10.DREA, Business Pundit, “10 Countries Least Affected by the US Financial Crisis,” (October, 2008) http://www.businesspundit.com/10-countries-least-affected-by-the-us-financial-crisis/