Economic models: is there an alternative to neoliberalism?

David Woodward, nef (the new economics foundation)

(Note for the Development and Environment Group, March 2007\0

Global Growth and Poverty

An estimated 40% of the world population are below the “$2-a-day” poverty line, and one in six below the “$1-a-day” line. It is conservatively estimated that low income levels materially affect life expectancy below about $3-4 per day, the effect increasing dramatically as income declines[1], and typical infant mortality rates at the “$1-a-day” are between one in six and one in six[2].

The current model of economic development relies on global economic growth to reduce poverty. However, global growth remains far below the levels achieved between 1945 and 1970; and the share of growth going to poor households is minimal, and has fallen dramatically even since the “lost decade for development” of the 1980s. The share of households below the “$1-a-day” line, in particular, is estimated to be barely half their share in global income, and barely one-quarter of what it was during the 1980s.[3]

As a result, the rate of poverty reduction (based on the “$1-a-day” line poverty line) has slowed dramatically, from 1.4 percentage points per year in 1981-90, slowing to 0.9 points per year in 1990-96 and just 0.4 points per year in 1996-2003 (Figure 1)[4]. At the same time, the narrowing of the average income shortfall of households below the “$1-a-day” line slowed from 1.9% pa in 1981-90, to 0.5% pa in 1990-96, and to zero in 1996-2001 (Figure 2)[5].

The result is that poverty was 50% higher in 2001 than it would have been had the rate of reduction in the 1980s been sustained (Figure 3). If global growth and the share of poor households in the proceeds of growth (relative to their share in income) were to continue indefinitely at their 1990-2001 rates, even in more than 550 million people (including nearly a quarter of Sub-Saharan Africans) would remain below the “$1-a-day” line.

Moreover, these results almost certainly under-state the extent of the problem, because analytical problems in the estimation and application of poverty lines mean that they both under-state the extent and over-state the rate of reduction of poverty[6].


This dramatic deterioration has occurred despite a considerable improvement in the global economic environment, from a development perspective, and the increasing application over most of this period of a neoliberal model of development whose rationale has been precisely to promote economic growth and poverty reduction.

Global Growth and Climate Change

It is now generally recognized that climate change is reaching critical dimensions; that it is a result of excessive concentrations of greenhouse gases, particularly carbon dioxide, in the atmosphere; and that the increase in concentrations is at least largely a result of anthropogenic emissions, primarily as a result of the direct and indirect effects of production and consumption. Other things being equal (including the rate of technological progress and trends in consumption patterns), a faster rate of global economic growth would imply a faster rate of increase of such emissions, and thus a more rapid increase in atmospheric concentrations, and an acceleration of climate change.

It is now generally accepted that a 60% reduction in carbon emissions from their 1990 level is required by 2050 merely to limit the increase in global temperatures to 2°C, which would itself have potentially serious consequences, not least for poverty. However, emissions have continued to increase, by a total of around 25% since 1990[7], implying a need for a reduction of 68% (2.6% pa) between 2007 and 2050.

However, if the post-1990 trend in global economic growth were to continue, this would increase global production and consumption by some 500% in real terms. This means that global carbon emissions per (real) dollar of production and consumption would need to fall by around 95% by 2050, equivalent to more than 6% per year, from their current level.

The post-1990 rate of reduction carbon-intensity of production (1.5% pa) falls far short of what is required to achieve this. If this rate of reduction were also to continue, global carbon emissions would not fall by 68% by 2050, as required, but would increase by 195% over the same period, to more than nine times the target level. Achieving the necessary reduction would require an immediate acceleration in the rate of reduction in the carbon intensity of production of 4½% pa (from 1.5% pa to 6% pa), which would then need to be sustained for the next 43 years. By comparison, the acceleration achieved between the 1960s and the 1980s in response to the oil price shocks of the 1970s – a real increase in world oil prices of 700%, which had a devastating impact on the global economy – was just 1% pa over the course of two decades[8]. Any shortfall in the rate of reduction in the early years would need to be off-set by a still faster reduction later.

Despite an extraordinary level of technological optimism, there is no evidence to suggest that an acceleration of this order can be achieved. On the contrary, the rate of reduction in the carbon intensity of world GDP actually slowed marginally from 1.6% pa in the 1980s to 1.5% pa in 1990-2003[9].

The Need for an Alternative

The above discussion suggests that our present (post-1990) trajectory, if maintained, will result in a serious failure to meet MDG1, or to eradicate poverty even by 2050, while rendering catastrophic and irreversible climate change inevitable long before then. Given the prominence of poverty reduction and dealing with climate change on the global agenda, this indicates a fundamental incompatibility between the current, neoliberal, model of development on the one hand, and our major objectives on the other.

This suggests an urgent need for an alternative approach to development which is capable of achieving both of these goals simultaneously. However, we have, for more than a quarter of a century, been told repeatedly that “there is no alternative”. Of course, other models of development have been pursued in the past – in fact, anything approximating neoliberalism was virtually unknown until about 30 years ago. And some, at least, of these other approaches have been much more successful in their time than neoliberalism has been more recently.

However, the current context is, in important respects, different from the past – not least in the challenges it presents. The question, therefore, is to what extent alternative models of development can meet the present challenges in the present context; and, if they cannot, what other options might be available which could do so more effectively.

Economic Models: a Typology

Widely adopted economic models in the post-1945 period can be broadly divided between six broad types:

  • central planning (eg the Former Soviet Union), characterised by state ownership of the means of production, and economic decision-making by government and public sector agencies;
  • state capitalism (eg the Former Yugoslavia), characterised by the domination of production by large state enterprises operating on a quasi-commercial basis;
  • import substituting industrialisation (eg Brazil), characterised by the use of import restrictions to foster domestic production of industrial goods for the local market, typically accompanied by other types of government intervention;
  • the “East Asian” model (eg Korea), characterised by a substantial level of government intervention in industrial policy, to “pick winners”, usually for domestic consumption with “infant industry” protection initially, but subsequently for export, often backed by temporary subsidies;
  • neoliberalism (eg Hong Kong), characterised by the (relatively) free operation of market forces and a limited role of the state, with a high level of openness to trade and financial flows, and (in developing countries) reliance on foreign investment; and
  • the social market economy (eg Sweden), characterised by a market system with a substantial level of regulation, relatively high taxes and strong social provision.

The Road to “No Alternative”

Central planning is generally recognised as having been a failure, and effectively came to an end with the fall of the Soviet Union – although the subsequent “economic transition” in many formerly centrally planned economies has imposed considerable economic and social costs. State capitalism, though less conspicuously unsuccessful has suffered a similar demise.

The end of import-substituting industrialisation (ISI) started earlier, following the beginning of the debt crisis in 1982, but took much longer. The widespread perception that it contributed to the debt crisis cast doubt upon its economic sustainability; and the conditionality of IMF and World Bank programmes on broadly neoliberal policies, and the establishment of the WTO in 1994 largely removed the ISI option.

While the East Asian model was conspicuously successful in terms of its economic and social results, it too has been undermined by the 1997 financial crisis (temporarily), and more lastingly by the conditions attached to the associated “rescue” packages and the advent of the WTO.

The social market economy has also been eroded by the process of globalisation, but has proved much stronger, primarily because it is characteristic primarily of developed countries who have been better able, financially and politically, to protect their interests. Realistically, more limited tax bases and external financial constraints characterising place it beyond the means of most developing countries.

The result has been a perception, particularly since the 1990s that “there is no alternative” to the neoliberal model (though with some evolution towards public health services and education and social safety nets), with the option of a constrained form of social market economy in developed countries.

The Failure of Neoliberalism

However, while the external constraints on policy space associated with globalisation have indeed narrowed the options available, these are primarily a political construct resulting from a succession of decisions taken through international fora. Even if individual governments have no alternative, there are alternatives available to the international community which would allow other policy choices – and a widespread view (characterised as “anti-globalisation”) that such options should be pursued.

This view has been greatly encouraged by perceived failures of the neoliberal model, particularly for the developing world. The adoption of the neoliberal model was predicated on the perceived failure of more interventionist models to generate adequate economic growth on a sustainable basis; and yet, as noted above, globalisation and widespread adoption of broadly neoliberal policy reforms over the last 25 years have had no impact in reversing the dramatic slowdown in the global economy in the 1970s; the rate of poverty reduction has slowed dramatically since the 1980s, and the reduction in the depth of poverty has stopped entirely since 1996; and there has been a dramatic slowdown (and in some countries a reversal) in the rate of improvement of life expectancy and infant mortality; but at the same time, climate change poses a fundamental challenge in terms of the environmental sustainability even of the current, relatively slow rate of global growth.

The results of neoliberal policies have been disappointing in Latin America, and little short of disastrous in Sub-Saharan Africa. By far the greatest economic success in the last 25 years has been in China, where the move towards neoliberalism has been relatively limited, and elsewhere in East Asia, where it has come much later in the development process than elsewhere.

Back to the Future?

The primary response to the failure of neoliberalism in developing countries has been calls, explicitly or implicitly, for a return to ISI or the East Asian model – and even a cursory glance at historical data suggests that economic and social progress was much faster when they predominated. However, beyond the need for an enabling environment at the international level, there are questions about the viability of either to deliver as a generally applied model.

The East Asian model shares one of the key weaknesses of neoliberalism as a universal model for development, namely its reliance on rapidly growing exports. While a relatively small group of (relatively small) countries can grow simultaneously through export growth, if the entire developing world does so simultaneously, the price effects on world markets can make the process self-defeating (cf the contributory role of increasing Chinese manufactured exports in precipitating the Asian financial crisis). The result would be to increase production in the developing world, without this increase feeding through into substantial (or potentially any) increases in incomes. The primary beneficiaries would be consumers, primarily in the North, whose incomes would also need to increase rapidly to sustain demand growth

The potential flaw of the ISI model – at least as applied in Latin America until the 1970s – is more subtle, and social rather than economic. The model relied heavily on the production of heavy industrial goods for the domestic market, substituting for imports. However, such production was relatively capital intensive, limiting the number of jobs created. At the same time, even as incomes increased, these goods were consumed primarily by people in the upper part of the income distribution. As the substitution process progressed, the system’s viability therefore became increasingly dependent on increasing demand in this part of the population, creating economic and political pressure for maintaining relatively high incomes rather than for poverty reduction. Coupled with a very high initial level of inequality, these features arguably limited the potential for the model’s success in generating economic growth to generate substantial poverty reduction.

Thus both models have shortcomings in terms of their reliance on rapidly increasing output coupled with limitations in terms of their ability to translate this into increasing incomes, at least in the lower part of the income distribution. In the past, this has not been seen as a fundamental problem: if a limited share of the proceeds of growth went to growth, it was assumed that this could be off-set by a faster overall rate of growth. However, climate change is making this increasingly questionable: binding carbon constraints, coupled with the inadequate potential for technological change to reduce the carbon intensity of global production, means that unlimited global growth is no longer an option.

Thus neoliberalism has failed – almost as clearly as central planning and state capitalism have failed, though in different ways; the social market economy is beyond the means of most developing countries; and it is questionable whether either ISI or the East Asian model is viable as a generally applied model in a carbon-constrained world.

Towards an Alternative: Poverty Eradication in a Carbon-Constrained World

This suggests an urgent need to develop a new alternative, designed to achieve the social objectives of the 21st century – poverty reduction (and ultimately eradication) and health and education for all – within our environmental constraints, particularly those imposed by climate change.

With more than 75% of global GDP in developed countries, and 85% of the world’s population in developing countries, any model which relies on exports and foreign capital to increase incomes and eradicate poverty in the South will require rapid growth in the North – that is, considerable further increases in the incomes and consumption of those already far above any conceivable global poverty line. This is almost certainly incompatible with prospective constraints on carbon emissions and feasible scenarios for the carbon intensity of global production.

This suggests that an environmentally sustainable model will need to be focused primarily on meeting local demand in developing countries using local resources. If such a model is to be effective in reducing poverty, however, the shortcomings of the ISI need to be addressed. This means moving away from reliance on large-scale capital intensive industry employing a small and relatively prosperous urban sector producing goods for a more prosperous middle class and elite, and towards production which is both produced and consumed by poor households, primarily in small-scale agriculture, rural and urban small and micro-enterprises and the urban informal sector, which are much more labour-intensive (and generally less import-intensive).

In other words, what is needed is a model which seeks to expand supply by, and the demand of, poor households in parallel. This could be fostered, for example, by income generation schemes promoting the production of goods whose consumption will be increased by poverty reduction (based on household surveys), using temporary import tariffs if necessary. A kick-start could also be provided, for example by public works schemes, cash transfers, skewing public procurement from micro-enterprise, etc.

In the long term, increased access to and quality of public health services and education will also be essential, as will adequate infrastructure and public sector administrative capacity. This indicates an urgent need to strengthen public revenues, particularly in low-income and Sub-Saharan countries.

While some aspects of such a model could be implemented in the global economy as it currently operates, some aspects of it – notably tax competition, debt-service costs, constraints on trade policies under WTO Agreements, etc – would be potentially problematic. Any model which focuses on benefiting poor households directly rather than as a by-product of making the rich richer would also face serious political constraints, both domestically and globally.

Conclusion

Nonetheless, if we are serious about poverty eradication and health and education for all, but recognise the imperative of living within realistic carbon constraints, none of the currently recognised models of development is likely to provide a viable option. The reality of climate change means that we now live in a fundamentally different context, which requires a fundamentally different approach to development.

We therefore need:

  • to recognise that globalisation in its current form and the neoliberal model of development have failed to deliver from an economic, social or environmental perspective;
  • to step back and undertake an objective assessment of the successes and failures of alternative economic models in terms of social and environmental objectives;
  • to seek to develop alternative economic models capable of delivering on social objectives as a generally applied economic model in a carbon-constrained world; and
  • to implement reforms to the global economic system, so that it will allow, foster and support the implementation of such models.

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