From Keynesianism to Neoliberalism: Shifting Paradigms in Economics By Thomas I. Palley April 2004 Thomas I. Palley is the chief economist at the U.S.-China Security Review Commission. This essay will appear as a chapter in a book by Deborah Johnston and Alfredo SaadFilho, eds., Neoliberalism--A Critical Reader (Pluto Press, 2004). The intellectual foundations of neoliberalism “(T)he 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. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slave of some defunct economist.” John Maynard Keynes, The General Theory of Employment, Interest and Money (1936), p.383. For the last 25 years, economic policy and the public’s thinking have been dominated by a conservative economic philosophy known as neoliberalism. The reference to “liberalism” reflects an intellectual lineage that connects with 19th century economic liberalism associated with Manchester, England. The Manchester system was predicated upon laissez-faire economics and was closely associated with free trade and the repeal of England’s Corn Law, which restricted importation of wheat. Contemporary neoliberalism is principally associated with the Chicago School of Economics, which emphasizes the efficiency of market competition, the role of individuals in determining economic outcomes, and distortions associated with government intervention and regulation of markets.1 Two critical tenets of neoliberalism are its theory of income distribution and its theory of aggregate employment determination. With regard to income distribution, neoliberalism asserts that factors of production--labor and capital--get paid what they are worth. This is accomplished through the supply and demand process, whereby payment depends on a factor’s relative scarcity (supply) and its productivity, which affects demand. With regard to aggregate employment determination, neoliberalism asserts that free markets will not let valuable factors of production--including labor--go to waste. Instead, prices will adjust to ensure that demand is forthcoming and that all factors are employed. This assertion is at the foundation of Chicago School monetarism, which claims that economies automatically self-adjust to full employment and that the use of monetary and fiscal policy to permanently raise employment merely generates inflation.2 1
Key figures in the Chicago School are Milton Friedman, George Stigler, Ronald Coase and Gary Becker--all of whom have been awarded the Nobel Prize in economics. 2 Monetary policy is conducted by central banks, who manage interest rates to affect the level of economic activity. Fiscal policy refers to government management of spending and taxation to affect economic activity. 1