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Saturday
Jun252016

Hayek and Friedman in Chile

I gave a talk last night on the role of economist as public policy advisor. In particular, I was interested in challenging the prevelent conspiracy theory that economic crises lead to neoliberal policies, which lead to bad outcomes.

I think this theory rests on two important pieces of ignorance about economics. The first is the conflation of neoclassicism (a method) and neoliberalism (an ideology). I explain more in this IEA blog post. The main point:

To the extent that ‘neoliberalism’ has come to dominate western policy making, it isn’t liberal. To the extent that ‘neoliberalism’ is extreme free market dogma, it’s of negligible impact.

The second area of ignorance is Public Choice theory. I argued that treating neoliberalism as being synonymous with corporatism simply ignores what "neoliberals" actually believe - we don't think that unemployment is due to individual weakness, but to instutitional barriers such as labour markets rigidities and occupational licensing. In other words "we" have a very clear theory of regulatory capture and crony capitalism. 

Notice that I am claiming the term "neoliberal". Indeed this brings us to Friedman and Hayek in Chile, because if this is an example of neoliberal intervention it is worth pondering what happened and challenge whether it's the smoking gun that critics to often claim. After documenting the role of Friedman and Hayek, I mentioned a great paper by Bob Lawson and J.R. Clark. They make the following definitions:

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    • Economic freedom – 0.5 standard deviations higher than average on the Economic Freedom Index
    • Political freedom – 1 standard deviation higher than average on the Freedom House Index (and average of “political rights” and “civil liberties”)
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This produces a 2x2 matrix where we can not only assign countries to various quadrants, but also map how they move between quadrants over time. I used this as a basis for "The Economic Freedom Parlour game" and it seemed to go down well.

According to Hayek and Friedman, you can’t have political freedom without economic freedom, which implies that quadrant B is unstable. According to Lawson & Clark's data, less than 10% of the data set is contained in quadrant B. In 1980, for example, there were 12 cases, and typically these were "high income Western nations who were in the final stages of their most socialist periods”. The fact that 11 of them (with the exception of Venezuela) subsequently becamer more economically free (B->A) seems to support their thesis.

We can also bring in the Road to Serfdom, where Hayek claims that when democratic socialism fails planners will move toward totalitarianism (i.e. B ->D). If we consider this to be a prediction (i.e. that it will necessarily happen) it looks to have been refuted. 11 of the 12 avoided that path. But if we consider it to be a warning, the sole example of Venezuela is validation. In other words, those European countries didn’t let the planners continue their planning, and neoliberalism saved the day.

According to Lawson and Clark the key findings are as follows:

  1. Chile's drastic increase in economic freedom was soon followed by increases in political freedom
  2. Israel's lack of political freedom in the 1970s/1980s didn't last, and relatively free-market policies have coincided with a steady increase in political freedom
  3. Venezuela really began to lose economic freedom from 1990-1995 and since then political freedom has fallen (and is falling).

This latter case - Venezuela - is the Road to Serfdom before our eyes. And I think the framework is a very interesting one to think about the dynamics of transition. Should we focus on moving from D -> B and hope that political freedom begets economics freedom (and run the risk of lapsing into the Road to Serfdom?); or should we aim for D -> C and risk getting "stuck" in an authoritarian but prosperous country like Hong Kong or Singapore. To help with this, I presented some of the key findings from my 2009 book on neoliberalism in Eastern Europe, and also shared Anders Aslund's point that it may be a false choice. The tradeoff may not be D -> C or D -> B but between D -> Cor nothing. After all,

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    “Market economic reforms have been highly successful, whereas democratisation has only been partially auspicious, and the introduction of the rule of law even less so” (2007, p.305)

    “At present, we seem to understand how to build a market economy, whereas the ignorance of democracy building and the construction of a legal system are all the more striking” (2007, p.311)

     

For me, Eastern Europe is an example of the success of neoliberalism. However the success could have been greater still.

The left falsely identify Friedman (rather than Hayek) as leader of the neoliberal revolution because they can pin more on him. But it’s Friedman’s neoclassicism (i.e. method) that dominated the economic and public policy debate, not his neoliberalism (ideology). We need more of it. 

 

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