Understanding the Neoclassical Counter-Revolutionary Theory: A Critical Analysis

Introduction

Many developed world governments during 1980s embraced a free market economics theory. This viewpoint was known as the Neoclassical Counter revolution (Skinner, 2011). Neoclassical is defined as any of the various intellectual movements that embrace a set of traditional principles regarded as fundamental or authoritative (Foley, 2007). Similarly, neoclassical economics is defined as economic approaches that focuses on the determination of income distribution, output and prices in markets through supply and demand (Foley, 2007). Neoclassical counter revolutionary theory according to Skinner (2011) supported regulation of economic activities of governments, statistic planning, private ownership and freer markets. The economist who supported neoclassical counter revolutionary theory argued that too much intervention by the state and poor allocation of resources was preventing markets from properly function and this hindered growth. The paper will discuss neoclassical counter revolutionary theory, its historical background, neoclassism Washington consensus, traditional neoclassical growth theory, neoclassical views, four component approaches, criticism and final a conclusion.

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Historical background

At the end of World War II, Snowdon (2007) indicated that the ideologies of the Soviet Union and United States were at logger heads. The two super powers could not come to a common ground on how best to reconstruct the economies of the nations that were destroyed by war. The strategies for developed proposed by United States aimed at spreading capitalism and containing communism in the whole world. The result conflict was referred to as cold war and the strategies of development was one of the many arenas where the cold war conflict played out.

After the fall of communism and the emergence of the United States, Britain, Canada and West Germany, there has been an increase in the number of democracies. However, during this period, the under developed countries were being left behind while the developed countries were progressing rapidly. Foley (2007) stated that the under developed countries governments started catching up. The governments that were conservative economically also obtained votes on the World Bank boards and also the IMF boards, hence challenging the arguments of the interventionists

One of the development models was the neoclassical counter revolutionary theory. This development theory also known as neoliberal reasserted its dominance over the structuralisms and also other schools of through. Based on the early economic thoughts, Neoclassical counter revolutionary theory aimed to spur growth economically.

Neoclassicism’s Washington Consensus

This term was first coined in 1989 by an economist known as John Williamson (Lee & Mathews, 2010). The term referred to a set of ten specific economic prescription policy that were regarded as constituting the standard package of reform promoted by institutions based in Washington DC such as IMF, US Treasury Department, World bank for developing nations that were wrecked by crisis. The economic prescriptions comprised of policies in areas such as economic opening, macroeconomic stabilization with respect to both investment and trade, and the expansion of forces of the market within the domestic economic economy. These economic prescriptions policies as listed by Lee & Mathews (2010) included:

1. Fiscal policy discipline
2. Interest rates
3. Tax reform
4. Reduce public spending
5. Competitive exchange rates
6. Trade liberalization
7. Foreign direct investments
8. Deregulation
9. Privatization of state enterprises
10. Property rights

Traditional neoclassical growth theory

According to Mehra, Piguillem & Prescott (2011), the growth of output results from one or a combination of the following factors according to traditional neoclassical growth theory:

1. Increase in labor quantity and quality
2. Capital increase from saving
3. Improvement and investment in technology

However, that the poor closed economies as far as they are concerned are characterized with very low saving rates. Their rates of growth, accordingly remain very low. In contrast, the economies where the rates of savings were higher than their incomes per capita, sharply rose. In the open economies presence, the capital outflowed to the poor economies from the rich economies where the labor capital ratios were lower and therefore the returns on investments were higher. Hence, the steps to impede foreign investment inflow on the part of governments of the under developed countries reported their growth (Mehra, Piguillem & Prescott, 2011).

Therefore, the neo classical free market theory’s cornerstone is linked with the domestic markets liberalization which will attract foreign and domestic investment. In this way, accumulation of capital in the under developed countries will increase. In terms of growth of GNP, this will be equivalent to increasing the rates of domestic saving which will enhance per capita incomes and labor capital ratios in capital to the developing countries that are poor (Mehra, Piguillem & Prescott, 2011).

Neoclassical views

Neoclassical counter revolutionary theory supported increasing free trade and exports, eliminating price controls by the government and attracting foreign investors. This arguments contradicted the argument proposed by the dependence theorists who had a view that the developed nations was exploiting the developing nations and hindering their growth. However, neoclassical counter revolutionary theory blamed the developing nation’s governments for not offering comic incentives and being often corrupt (Skinner, 2011). The proponents of the theory included Deepak Lai, Peter Bauer, Harry Johnson, Ian Little, Julian Simon, Bela Blassa, Ann Krueger and Jagdish Bhagwati argued that the under development in the developing countries was as a result of incorrect pricing policies, poor resource allocation and excessive state intervention. This consequently has slowed the rate of growth in the under developed countries (Snowdon, 2007).

Neoclassical counter revolutionary theory is based on the argument that when markets self-regulate themselves, they become more effective. This implies that the forces of supply and demand will determine consumptions and production, and that all producers and consumers collective will allocate the resources in a better way compared to what a central body is capable of allocating. Furthermore, under this theory, any intervention by government interfering with this self-regulation of the market that is automatic will distort the market prices and eventually hamper growth. According to Skinner (2011), this argument is also advocated by the most powerful financial institutions globally such as the World Bank and International Monetary Fund. These global financial institutions efforts in providing incentives for the developing countries to embrace the free market approach have seen success by causing change in most of these countries. The counter revolutionists or the neo classical economists gave examples of the Asian tigers such as Taiwan, South Korea, Singapore and Hong Kong among others who simulated their economies marvelously on the price mechanisms and free markets. In contrast, the Latin America and African economies failed despite depending on the interventionist’s policies. Additionally, they encourage the governments of the developing nations to establish string financial systems with high transparency levels, and also the governments to make investments in education and key infrastructure

On the other hand, it is argued that through this liberalization process, more foreign investments is attracted. According to Mehra, Piguillem, & Prescott (2011), foreign capital get attracted to markets that are stable and free. Moreover, they also get attracted by the stability of the country’s democracy, financial systems that are transparent and security. Foreign capital infusion is equivalent to increasing the rate of savings, which can be shown to raise GDP using the growth model of Harrod-Domar.

Friedman (1999) indicated that generally, free markets and democracy go together. The freedom of choosing political leadership of a country and also allocating resources as one perceives fit important. Governments that are democratic provides stability in a country since their provide methods of curbing corruption and a change model that is oriented towards the peoples best interest and the entire economy, instead of a particular political party or leader.

Four component approaches

The neoclassical counter revolutionary theory challenge can be divided into four compositional approaches

The free market analysis

Foley (2007) indicated that with this approach, the markets are efficient alone as the goods markets offers a signal to invest in new activities. Furthermore, the labour markets properly shows the reaction in new industries automatically. Additionally, n.a (2015) asserted that the entrepreneurs understand better what need to be produced and they are supposed to be produced, as the goods prices and the factor truly reflect scarcity of the future and present pries. Even if perfect competition is not existing, such still remains effective. The people have the total freedom of inventing new goods. Similarly, each economic agent avails easily less or more freely all the information.

According to Foley (2007), is such scenarios, any intervention by the government will not be productive and will only lead to creation of distortions. Therefore, the development economists supporting the free economies argue that if free market economic systems are implemented all over the world, it will lead to a more efficient scenario, and the imperfections of the market will of least significance.

Modern political economy/ public choice theory

This theory/approach states that the government does not do anything good. According to Snowdon (2007), the theory is of the view that the bureaucrats, politicians, state and citizens’ function based on their interests. This implies that they us the power, authority and government for their own personal interests. The citizens achieve some of their objectives (rent) with their political influence through the policies of the government, as they often engage in getting license for import or minimal foreign exchange. On the other hand, the politicians uses the resources of the government to maintain or cumulate their authority or power. Whereas, the state are often found keen on confiscating private properties. All these factors leads to losing of personal freedoms and misallocation of resources. Therefore, this approach advocates for minimal or limited government size.

Market friendly approach

This approach according to n.a (2015) is the Neo-Classical counter revolution theory’s present variant that is available literature of World Bank and its economists who were its great advocates during 1980s in the catnip’s public choice and free market. This approach accepts availability of imperfections in the factor and product markets of under developed countries. Accordingly, the government need to play a vital role for the markets to function well. However, the government will have to adopt the market friend approach when playing its role since the government will have to crease a favorable and suitable environments for private businesses by providing them with educational facilities, healthcare and physical infrastructure

This approach is different compared to the public market approach and free market approach, since it admits existence of greater market imperfections role in the under developed countries. Additionally, due to investments, a person finds externalities. The imperfections either remain missing or are available in limited amount. Moreover, a person finds externalities in regard to learning, and realizing attainment of scale become weaker in the under developed countries markets (Foley, 2007).

New Institutionalism Approach

This approach emphasizes that outcomes of development depend on institutions like market and price structures, property rights, financial and money institutions, industrial and firms organizations, and relationship between markets and governments the good governance essence is to ensure these institutions existence and their functioning and roles. The new institutionalism approach elaborates the concept of good governance which requires freeing the markets from regulation and control by the state; reducing expenditures by the government for social services like health care and education; maintaining bridges, roads, water supply and many other social amenities; selling goods, services and enterprises that are owned by the state including key industries, banks, toll highways, railways, schools, electricity and hospitals to the private investors (Snowdon, 2007).

Criticism

Dependence revolution according to Skinner (2011) was observed during the 1970s in the development economic literature where the theorists supporting the dependence theory regarded under development as a phenomenon that is externally induced. However, the 1980s, n.a (2015) indicated that the free markets proponents brought in the counterrevolution which was named as the neo-classical counter revolution. They considered underdevelopment as a phenomenon internally induced by the less developed countries which is surrounded by bad economic policies and government interventionists. However, the critical question arose as to whether less government intervention and free markets will be important in economic development attainment to the under developed countries. The answer is definitely not positive, and the following arguments were brought forth.

The organizational, institutional, political, social and economic structure of the under developed countries are different compared to the western countries that are developed. Accordingly, the policy percept and assumptions of the neo classical theory will not be very much applicable to the cases of he under developed countries because of the following factors as outlined by n.a (2015):

1. They lack competitive markets.
2. The under developed countries economies are characterised with market imperfections
3. The consumers lack sovereignty
4. They have fragmented markets with limited available information regarding investment opportunities, employment and production techniques
5. The money market is segmented into unorganized and organized markets
6. The people in the developing countries are also highly illiterate
7. Most of the economies in underdeveloped countries are also still not monetised
8. The speculate activates in these countries are preferred over the manufacturing activities
9. The land is considered a token of prestige instead of an income source
10. Existence of a big divergence between social benefits and private benefits
11. The societies that are poor have to face both production and consumption externalities
12. Existence of discontinuities in indivisibilities and production such as economies of scale in technology
13. The producers whether public or private have a great power in determining quantities sold and market prices
14. The idealism and utopia of competiveness is hardly available in the under developed countries , for example in Pakistan
15. The markets in under developed countries are also characterised with structural bottlenecks and disequilibrium
16. Similarly, the response to age and price movements in these countries can be perverse, in that they are not in equilibrium direction
17. Existence of monopolies in connection with product sale and purchase of resources
18. In other under developed nations like Pakistan, the Lewis model of unlimited labour supplies is applicable, that is, the availability of unlimited amount of labour at the wage rate that is prevailing. In such scenarios, the wages in the country will continue remaining depressed and this benefits the earners of profits at the cost of earners of wages. Therefore, in poor countries like Pakistan, the invisible hand will not promote peoples general welfare but instead it will continue lifting up those who are well off already by pushing the majority of people down. This implies that the poor economies resources will shift favouring the rich elites in these economies.

The international payment systems liberalization, for instance, conversion of local currencies in underdeveloped countries in dollar and open purchase and sale of dollars will further put these economies in more problems when they are having higher import base and poor export base. Additionally, the under developed nations do not possess anything to counter the challenges that would come after the promulgation of the World Trade Organization rules. In such scenarios, the dependence of the under developed countries on international agencies such as IBRD and IMF will increase where they will be victimised by these agencies conditional ties.in such state of affairs, there will be nothing more than what the neo-Marxist theory of growth once described.

Conclusion

In conclusion, the paper examined neoclassical counter revolutionary theory, its history, neoclassism Washington consensus, traditional neoclassical growth theory, neoclassical views, the four component approaches and its criticism. The evidence shows that a free market system that is democratic has a higher likelihood of attracting foreign investment and also showing sustained growth. As much as the Neoclassical counter revolutionary theory has its challenges, the question that need to be addressed is what type and how much intervention will create the best balance.

References

Foley, D. (2007). Reply To: “the New Classical Counter-Revolution: False Path or Illuminating Complement?”. Eastern Economic Journal, 33(4), 563-565. doi:10.1057/eej.2007.41

Friedman, T. L. (1999). The Lexus and the olive tree. New York: Farrar, Straus, Giroux.

Lee, K., & Mathews, J. (2010). From Washington Consensus to BeST Consensus for world development. Asian-Pacific Economic Literature, 24(1), 86-103. doi:10.1111/j.1467-8411.2010.01251.x

Mehra, R., Piguillem, F., & Prescott, E. (2011). Costly financial intermediation in neoclassical growth theory. Quantitative Economics, 2(1), 1-36. doi:10.3982/qe40

n.a,. (2015). Neo-Classical Counter Revolution Theory – Approach to Privatization and Free Market – Criticism – Economicsconcepts.com. Economicsconcepts.com. Retrieved 16 August 2015, from http://economicsconcepts.com/neo_classical_counter_revolution_theory.htm

Skinner, G. (2011). The Neoclassical Counterrevolution and Developing Economies: A Case Study of Political and Economic Changes in the Philippines. Google.com. Retrieved 15 August 2015, from https://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=2&cad=rja&uact=8&ved=0CCcQFjABahUKEwjfwu7ZhazHAhWBuhoKHdrNBMM&url=http%3A%2F%2Frepository.wcsu.edu%2Fcgi%2Fviewcontent.cgi%3Farticle%3D1059%26context%3Dssj&ei=yLDPVd–D4H1atqbk5gM&usg=AFQjCNGzRsFtZeGByCy0cH2Uq7OxpN_6Uw&sig2=c8Ta_sXv7Ny49-jDIezwYQ&bvm=bv.99804247,d.d2s

Snowdon, B. (2007). The New Classical Counter-Revolution: False Path or Illuminating Complement?. Eastern Economic Journal, 33(4), 541-562. doi:10.1057/eej.2007.40

Herman Bailey

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