Although this is my first non-monetary post, even this project started with monetary economics. I had published a paper arguing that new Keynesianism was a synthesis of monetarist and old Keynesian ideas (which is where I cited Brad Delong’s paper.) The basic idea was that economists originally misinterpreted the Great Depression. They thought it showed monetary policy to be less effective than fiscal policy (because they failed to understand how the gold standard had constrained monetary policy), and thought that the economy did not naturally self-correct back to full employment (because they overlooked the impact of FDR’s high wage policy.) By the early 1980s they understood that they had overreacted, and built a new Keynesian model with elements of the old (sticky wages and prices, interest rate targeting, activist policy), and elements of monetarism (the natural rate hypothesis, highly effective monetary policy.) Then I noticed that this Quantity Theory–> Keynesian–>new Keynesian dialectic was uncannily similar to what had occurred the in the broader field of economic liberalism.
(Hang in there, the first half of this post is necessary but boring, but the second half is interesting.)
Classical liberalism began evolving into modern (socialist) liberalism in the late 19th century, and the changeover became complete after the Great Depression made capitalism look not just unfair, but inefficient. But once we realized that the problems of the 1930s required nothing more than inflation targeting, we began to prune back on the more counterproductive statist policies that had built up between the 1930s and the 1970s. In particular, I noticed that after 1980 almost all countries cut marginal tax rates, privatized, and deregulated prices and market access. Yet there wasn’t much change in the size of government (as a share of GDP.) Outside the U.S. this new synthesis is called “neoliberalism,” although it might just as well be called postmodern liberalism. So it seemed to me that the most sensible way to view neoliberalism is as a synthesis of free markets and egalitarian social insurance, roughly what Tony Blair called the “Third Way.”
This made me wonder what the term ‘liberal’ actually means? Or more pragmatically, what is the most useful definition of liberalism? I find it useful to think of liberals as people with idealistic, progressive, and most importantly, somewhat utilitarian (or at least consequentialist) value systems. And that the three different types of liberalism (pragmatic libertarian, socialist, and neoliberal) actually represented people with similar values, but differing views of how economic systems work. (The normative/positive distinction is less clear cut than many economists assume, but it’s roughly the distinction that I am making here.)
Let’s call positive views about cause and effect “worldviews.” Then my hypothesis is that there are two basic worldviews, the economistic worldview (imports are good, markets set prices, etc.) and the commonsense worldview (imports are bad, oil companies set prices, etc.) The relative popularity of right wing versions of liberalism (laissez-faire) and left wing versions of liberalism (democratic socialism) depends on the relative plausibility of each worldview. As the term ‘commonsense’ suggests, we right wing liberals are at a disadvantage–indeed it is only because we are correct that we make any headway at all. Bryan Caplan has done some interesting research on what I call ‘cognitive illusions,’ which I may discuss in another post.
So after 1980 “brute facts” about the weaknesses of statism pushed most of the world toward free markets. But there was (as yet) not enough evidence to abandon the egalitarian systems of social insurance. If I am right, then countries with more liberal values should have responded to this new information by becoming much more free market oriented, but not necessarily by reducing the size of government. But how do we measure liberal values?
I ran across a paper by two French economists, Algan and Cahuc, which showed that countries with a high level of civic trust (such as the Nordic countries), tended to have generous unemployment compensation and fewer restrictions on firing workers, and countries with less generous benefits tended to have more rigid labor laws. I realized that their measure of values (a survey question asking “would you accept government benefits to which you were not entitled?”) was perfect for my research.
They found Denmark to have the most civic honesty, but when I used a more complete sample of developed countries, Denmark was just edged out by Malta. But I also had a nagging worry about self-reports on honesty (“You Maltese say you are honest, but . . . ) Thus I decided to average this self-described civic honesty metric with a more objective survey—the corruption index produced by Transparency International (which was topped by Denmark.) When the two indices were averaged Denmark moved far ahead of the field—if its score was set at 100, the next three countries were tied way back at 86. Because of this blog’s growing popularity, I won’t mention how far Malta slipped, as I wouldn’t want to embarrass any readers from that tiny island nation.
Then I decided to measure neoliberalism by using the (2008) Heritage Institute’s Index of Economic Freedom minus the two “size of government” components (taxes and spending.) If one simply averaged the other eight components, Denmark edged ahead of Hong Kong as the surprising winner of “most free market economy on earth.” I was pleasantly surprised by this finding (achieved without any data mining) as it beautifully fit my dialectical approach to neoliberalism.
Even better, I found this index of neoliberal (or free market) policies was strongly correlated with my index of “liberal” (or idealistic) values. Indeed the correlation is even pretty strong for the unadjusted Heritage Index of Economic Freedom (despite the fact that that index is topped by a country, Hong Kong, with considerably less liberal values than Denmark. You’re probably thinking, OK, but correlation doesn’t prove causation. Lots of country characteristics are positively correlated. And what my hypothesis actually requires is that a place like Denmark only became highly free market-oriented after the changing intellectual climate made liberals less enamored with statist policies.
To get data going back to 1980, I had to use the Fraser Institute’s Index of Economic Freedom, a (surprisingly fierce) competitor to the Heritage Index. Here the results were even more gratifying. My first regression showed that the more liberal a country’s values, the more rapidly it moved away from statism after 1980. How about that, Naomi Klein? Between 1980 and 2005 only New Zealand moved toward free markets more rapidly than Denmark. My interpretation is as follows. Free market reforms threaten to erode rents earned by various special interest groups. Thus after 1980 these reforms were more likely to occur in countries where the civic culture is more oriented toward the common good. (In other words if you hear that culture is “tribal,” or that “family comes first,” it’s economy is likely to have statist economic policies.)
My initial reaction was that Deirdre McCloskey would love this finding. I had just published a long-winded 27 page book review of her fascinating (but equally long-winded) The Bourgeois Virtues. In that book she fires her shots in both directions at once. She concedes the good intentions of those on the left, but scolds them for not being more open to what I called the economistic worldview. Indeed many don’t even understand that such a worldview exists. She thinks people on the right such as George Stigler were right about free markets, but wrong about values. Stigler had argued that it is a waste of time for idealistic economic researchers to try to persuade policymakers, as the later group is motivated by self interest. And rent seeking special interest groups are more able to satisfy those interests then are idealistic economic professors. McCloskey countered that one cannot run a sound economic system on just self interest.
My findings suggest that Stigler is wrong, as the more idealistic a country’s values, the more rapidly they moved toward free markets when statism became discredited. But to people like Paul Krugman, Joe Stiglitz, James Galbraith and Naomi Klein, the findings are equally inconvenient. Far from being a right wing plot, the strong move toward freer markets and lower marginal tax rates that occurred in almost all developed countries after 1980 was actually driven by idealistic values, indeed I would argue by “liberal” values.
As this was my first foray into a cross-sectional study of country characteristics, I kept coming across other data sets. I couldn’t help noticing that the Nordic countries stood out in all sorts of different ways. For instance, Denmark had the world’s most equal distribution of income in two different surveys. Denmark also came in number one in all three happiness surveys that I was able to find. Interestingly, there isn’t much evidence that egalitarian systems produce happiness, rather the causation seems to go in the opposite direction. (Anyone interested in happiness research should first check out Will Wilkinson’s skeptical take on the whole enterprise.) Even so, I couldn’t help wondering what was so special about this seemingly ordinary northern European country. How could one country be the most egalitarian, and the most free market, and the most idealistic, and the happiest place on earth? Was there something in the water? Does Denmark somehow provide the secret key to all the social sciences? In other words (sorry, I can’t resist):
Is there nothing rotten in Denmark?
Actually there is. They have fairly high marginal tax rates, and hence they are somewhat poorer than Switzerland, and even farther behind ultra-low tax Singapore. These three countries, each with fairly similar populations, became my models of hyper-egalitarian liberalism, hyper-democratic liberalism, and hyper-economistic liberalism. I’ll consider Switzerland’s political system in another post, but let’s finish up this overlong post by briefly comparing the two extremes of neoliberal economic policies, Denmark and Singapore. You already know about Denmark, but Singapore also has a decent system of social insurance (universal health care, etc.) The difference is that Singapore achieved this result through a system of self-insurance, i.e. forced saving at roughly 33% of income. (With government transfer payments merely covering the gaps in the system.) This allows Singapore to have very low taxes on labor, and almost no taxes on capital and trade. And it has fully funded private retirement accounts. And health saving accounts. And huge budget surpluses. A nation ruled over by hundreds of Martin Feldsteins. (Sounds like a lot of fun!) As a result, Singapore has a per capita GDP (in PPP terms) as high as any non-oil country on earth (or any with at least million people.) Denmark is also reasonably prosperous, but far below Singapore.
So which is the model for the 21st century? Which should China and India try to emulate? Let’s compare the two:
Lars von Trier films
The happiness data suggests Denmark, except that as I already noted there appears to be reverse causation. And Algan and Cahuc argued that the less civic-minded countries couldn’t afford generous unemployment insurance because they were populated by people who said “yes” when asked if they’d accept government benefits to which they were not entitled. And just so people don’t think I’m singling out one or two countries, almost everyone is far behind the Danes in civic virtue.
So perhaps for now China and India should settle on the Singapore model (preferably without the petty authoritarianism.) But I am not as pessimistic as most about the possibility of changing cultural values. I think McCloskey is on to something when she argues that free markets promote bourgeois virtues. I don’t expect to live long enough to see a world where Afghan tribesmen have a culture indistinguishable from the Danes, but I do think the world is moving in that direction.
Which brings me back to monetary policy. I argued that a misdiagnosis of the Great Depression led the world into a long, fruitless experiment with statism. Forty years in the wilderness. It is not hard to see the danger we face today. That’s why I am so passionate about diagnosing the current crisis correctly. Which brings me back to my previous post. Does anyone have connections with someone who can pass my previous post on to Paul Krugman, so we can quickly recover from this recession and get on with ending history?