People's Democracy

(Weekly Organ of the Communist Party of India (Marxist)


No. 12

March 29, 2009


Neo-Liberalism On The Brink Of Failure

Prabhat Patnaik

Neo-liberalism is in obvious retreat. Its three main components, viz. trade liberalisation, financial liberalisation, and enforcement of “sound finance” through the avoidance of significant fiscal deficits, are in the process of being negated everywhere. President Obama’s exhorting his countrymen to “buy American”, and wanting to penalise companies resorting to business outsourcing, are the first steps towards protectionism. The acquisition of State control over large chunks of the financial sector in the US and the UK reverses the trend towards financial liberalisation; and even “nationalisation”, in the sense of the total dispossession of current owners and large creditors, of financial giants, is being discussed as a condition for putting tax-payers’ money into capitalising them. Increases in fiscal deficits through various stimulus packages are much in vogue. Neo-liberalism at present is clearly passé.

The real issue however is whether this represents only a passing phase until the crisis has blown over and things have returned to “normal”, or the end of the road for neo-liberalism. The adherents of neo-liberalism believe this retreat to be temporary. They expect the financial sector, once “normalcy” has returned, to be re-privatised; they expect that Obama’s protectionist rhetoric will remain only rhetoric; and they expect fiscal deficits to narrow once the economies are out of recession. But even in their best-case scenario there can never be a return to square one. What the crisis has done is to demonstrate to everyone that the unfettered functioning of markets can bring disaster; hence even after the crisis is over, whenever it is, there will be much greater regulation of financial markets. The need for regulation is an issue on which both the Americans and the Europeans agree, notwithstanding their differences over whether the fiscal stimulus should get priority over regulation or the other way around. The crisis has certainly destroyed the credibility of the neo-liberal ideology; and this will have a lasting impact even in the best-case scenario for the proponents of neo-liberalism.

But in fact the crisis will not be over soon, and that is precisely because of the residual legacy of neo-liberalism, which is the ideology of international finance capital, whose hegemony, notwithstanding all the jolts it has taken, is not so easy to shake off. And, paradoxically, the lingering influence of neo-liberalism, derived from the continuing hegemony of finance capital, will threaten neo-liberalism to an even greater extent over time, precisely by making the crisis more protracted.


The obvious panacea for the crisis is the injection of demand into the system through public expenditure; the injection of liquidity alone is not enough, since both financial institutions and individual wealth-holders simply absorb all such injected liquidity, without stimulating private demand via easier credit. The reason for this lies in their excessively high liquidity preference at present induced by the crisis itself (some have called this situation a “liquidity trap”). And if such injection of demand through public expenditure is to be effective, then it is better done through a coordinated expansion of such expenditure across a host of major economies, rather than by individual economies in isolation. But international finance capital does not like such a coordinated expansion; not surprisingly, there is no sign of it. The US and China have announced fiscal stimuli, but the US stimulus is too small to make much difference to the world (and China is not yet in a position to make much difference anyway). Europe refuses to launch, let alone coordinate, any significant fiscal stimulus.

Finance capital’s antipathy towards any expansion of public expenditure, or indeed towards any assumption of a proactive role by the State, except when such activism is directed towards its own interests, is well-known. In 1929 when the Liberal Party leader Lloyd George, on Keynes’ advice, had asked for the launching of public works programmes, financed by government borrowing, for combating unemployment in Britain, the British Treasury, under the influence of British finance capital, had summarily turned it down. Likewise, all proposals for a coordinated expansion of government expenditure across major countries, mooted for instance by a group of German trade unions and also by Keynes himself, were shot down even in the midst of the Great Depression of the 1930s. Indeed, Keynes remained a neglected figure in his own country prior to the war. Even Roosevelt’s New Deal, which is often supposed to have been inspired by Keynesian ideas, was a pretty tepid affair in the beginning. The moment an increase in public expenditure, through a larger fiscal deficit, had started off a recovery in the US, Roosevelt, under pressure from financial interests, cut back the fiscal deficit, precipitating another recession in 1937, from which the US economy finally came out only when war preparations began towards the end of the decade.

Notwithstanding the availability of the Keynesian prescription, capitalism recovered from the Great Depression only through war preparations. Japan was the first to overcome Depression through the re-armament drive of its military-fascist regime, and was followed by Germany after the Nazi takeover. Liberal capitalist economies overcame Depression only towards the end of the thirties when they began arming against the fascist threat. And the reason for this persistence of Depression lay in the fundamental opposition of financial interests to enlarged public expenditure (an opposition overcome only under fascism where they directly control State power in alliance with fascist upstarts, and where larger public expenditure is in any case for militarism).

The reason for this opposition lies above all in the fact that any proactive role of the State in operating a capitalist economy undermines the social legitimacy of the capitalists: if the State can run enterprises effectively, if the State is required for the smooth running of the system, then why have capitalists at all? This question acquires even greater pertinence in the case of those capitalists who represent financial interests and constitute in Keynes’ words “functionless investors” anyway. Hence restricting the role of the State to merely promoting its own interests (whose promotion is made out to be necessary for society as a whole) is what finance capital always wants.

This opposition was overcome in the post-war years only because of a relative weakening of the position of finance capital. The war changed the correlation of class forces in advanced capitalism: there was a certain decline in the social and political weight of finance capital and a corresponding increase in that of the working class which marked the ascendancy of (old-style) Social Democracy and paved the way for the introduction of Keynesian demand management. But with the process of centralisation of capital giving rise to the formation of huge blocs of finance, and ultimately to the phenomenon of “globalisation of finance”, finance capital, in the new garb of international finance capital, re-acquired the strength to overcome Keynesian demand management and usher in the regime of neo-liberalism and globalisation. Finance capital’s opposition to State activism in short never disappeared even in the heyday of such activism.


This explains why international finance capital even at this moment is less than happy with fiscal stimuli in the form of larger State expenditure (which, for political acceptability at large, have to be directed towards the welfare of the people). It would rather have the State using public funds to “bail out” the financial system (without disturbing the position of the owners), until the next “bubble” comes along to initiate recovery. (It is instructive in this context that in India while the government has accepted the need for a larger public expenditure stimulus, it has deftly tried to use this stimulus for larger “viability gap funding” under PPP, i.e. for putting more public money in capitalists’ hands).

This opposition to fiscal stimuli will certainly delay recovery, which will prolong the distress of workers thrown out of jobs, and of peasants and petty producers suffering from adverse terms of trade. This will bring home to people in an even more stark fashion the bitter consequences of neo-liberalism, snuffing out any remaining chances of its making a comeback. Finance capital’s opposition to any abandonment of the neo-liberal tenets therefore will paradoxically undermine even further the prospects of survival of neo-liberalism. But then capitalism, not being a planned system, is always characterised by such paradoxes.

There is an even deeper reason, apart from the pervasive demand for “regulation” and the fact that the crisis is likely to be a protracted one, why neo-liberalism has reached the end of its tether. Any capitalist economy with “free” asset markets, especially “free” financial asset markets, is marked by the formation and bursting of “bubbles” in such markets. While the formation of “bubbles” strengthens the boom, the bursting of “bubbles” plunges the economy into a slump. It recovers from the slump only when some “external” source of demand, i.e. “external” to the regime of “free market capitalism” itself, happens to be present. Throughout its history therefore whenever capitalism has had such an external crutch, it has performed well on average, even as “bubbles” have been formed and burst, i.e. even through the phenomenon of the superimposition of “bubbles”. The booms in such situations have been pronounced, while the slumps have been relatively short or shallow, since the external crutch has been used to lift the system out of such slumps. On the other hand whenever such an external crutch is absent, the system witnesses Great Slumps following the bursting of “bubbles”.

In the pre-first world war period, capitalism had the crutch of the so-called “expanding frontier”. Millions of Europeans migrated to temperate regions of white settlement like the United States of America, Australia, New Zealand, Canada and South Africa, and captured land by driving away the original inhabitants. Their direct and indirect demands for goods and services in their new habitats, including for infrastructure, kept up the level of aggregate demand in world capitalism, and even gave rise to substantial capital export from the old capitalist countries, much of it financed through the extraction of surplus from tropical colonies like India.

This process came to an end with the first world war, so that the inter-war period may be seen as one where capitalism did not have any such external crutch. It had lost its earlier crutch but had not yet developed any new crutch. Not surprisingly, it experienced the Great Depression in this period. With the bursting of the 1920s “bubble”, the slump that set in could not be alleviated through recourse to any external crutch, since the old crutch did not exist and nothing new had taken its place.

Keynes’ prescription that State expenditure should provide a demand stimulus was an attempt to give capitalism a new “external” crutch. The prolonged boom of the post-war period was a result of the fact that the system had acquired this new crutch. But with the demise of Keynesian demand management, after the emergence of international finance capital and the institutionalisation of neo-liberal regimes, capitalism was once again left without an external crutch, exactly like in the inter-war period. Not surprisingly, with the collapse of the “bubble” of the 1990s, it is plunged once more into a Depression that is reminiscent of the Depression of the 1930s. Unless it can find a new external crutch, the system will remain submerged in crisis, with small ups and downs around a basically stagnant state.

Such a new crutch realistically can only be State expenditure, but within a new regime that overcomes the infirmity of the old Keynesian regime. For instance, the coordinated fiscal stimulus mentioned earlier may have to be institutionalised in some manner, so that it becomes a permanent feature of world capitalism rather than being merely an episodic arrangement to counter slumps. But capitalism is not a planned system; what new crutches become available to it is not simply a matter of developing some ideas and putting them into practice. As mentioned earlier in the context of the emergence of Keynesianism, the arrangements that come into being under capitalism are ultimately the outcome of class struggle; and where such struggle leads society, whether to a prolonged deadlock, or to some new capitalist arrangement, or even to a system beyond capitalism altogether, cannot be predicted beforehand. What is clear however is that the period of widespread acceptance of the neo-liberal capitalist arrangement is over.