A woman works at her grocery store in the Dharavi slum area of Mumbai, India. (Photographer: Dhiraj Singh/Bloomberg)

Free-Market Failure Has Been Greatly Exaggerated

(Bloomberg View) -- Harvard economist Dani Rodrik has a long and thoughtful essay about the shortcomings of neoliberalism -- the economic program of free markets and free trade. He writes:

Economists’ contributions to public debate are often biased in one direction, in favor of more trade, more finance, and less government. That is why economists have developed a reputation as cheerleaders for neoliberalism, even if mainstream economics is very far from a paean to laissez-faire. The economists who let their enthusiasm for free markets run wild are in fact not being true to their own discipline.

As someone who has done decades of pioneering work in the field of trade and growth, and who has been intimately involved in practical policy-making, Rodrik is as much of an expert on this topic as anyone . But although his criticisms are accurate, he overlooks much of the good that neoliberalism has done.

Rodrik very wisely explains why it's so easy for economists to seem like shills for simplistic free-market policies. Confronted with a desire for quick fixes and easy explanations, many economists instinctively revert back to the toy models they learned in their introductory economics courses -- models where free-market competition solves almost any problem. As Rodrik notes, these models represent a common fable -- University of Connecticut law professor James Kwak calls it "economism" -- that ignores a million and one important features of real-world markets. Government institutions, for example, matter a lot -- from the corporatism of 20th century Japan to Germany's innovative unions, there are many flavors of capitalism that all seem to work fairly well. And without good institutions, capitalism can easily degenerate into inefficient monopoly, crash-prone financial excess, short-sighted environmental destruction, or a number of other undesirable conditions.

But when it comes to the harms that neoliberalism has wrought, Rodrik cherry-picks quite a bit. He focuses on two countries -- Mexico and Chile. In the 1970s and 1980s, under dictator Augusto Pinochet, Chile took advice from a number of free-market economists, but the results were underwhelming. Since undertaking its own free-market reforms and signing the North American Free Trade Agreement, Mexico's economy has underperformed more interventionist countries like South Korea and China.

These examples of neoliberal disappointment are real enough. It's no accident that both come from Latin America -- the region where neoliberal advice, in the form of a 10-point plan called the Washington Consensus, garnered the most publicity. The Washington Consensus has been the target of bitter criticism for years, and Rodrik himself has been one of its most prominent detractors.

But Latin America is only one part of the world. Elsewhere, broadly neoliberal ideas have been much more of a success. Rodrik's essay should have taken these into consideration.

Take China. In the 1980s, after decades of economic and social disaster under Mao Zedong, China started experimenting with a market economy under party leader Deng Xiaoping. The regime began to allow small businesses and granted limited land rights. State-owned enterprises were partially privatized. The country opened to foreign investment, and went from a state of isolation to the world's biggest trading economy. By 2005, China's market economy passed its state-run economy in size. What happened after China's market reforms is now well-known -- the most dramatic explosion of economic growth in world history.

As Rodrik points out, state intervention still plays a prominent role in China's economy. But the shift from a rigid command-and-control economy to one that blended state and market approaches -- and the liberalization of trade -- was undoubtedly a neoliberal reform. Though Deng's changes were mostly done in an ad-hoc, common sense manner, he did invite famed neoliberal economist Milton Friedman to give him advice.

A decade after China began its experiment, India followed suit. In 1991, after a sharp recession, Prime Minister Narasimha Rao and Finance Minister Manmohan Singh scrapped a cumbersome system of business licensing, eased curbs on foreign investment, ended many state-sanctioned monopolies, lowered tariffs and did a bunch of other neoliberal things. Although the results were not as dramatic as in China, there was a sustained rise in economic growth:

Free-Market Failure Has Been Greatly Exaggerated

It's almost impossible to overstate how important the growth explosions of India and China have been. So many people live in these two supergiant countries -- almost 40 percent of humanity, several times the total living in the developed world -- that together they determine the entire shape of human progress. During the last three decades, India and China have done more to reduce world poverty than any other force in history:

Free-Market Failure Has Been Greatly Exaggerated

Dry facts and figures shouldn't obscure the poignant human reality of this miracle. People who once bathed in dirty rivers, defecated outside and saw a quarter of their children die before age 5 are getting food, shelter and clean water. Hundreds of millions of indigent farmers have moved on to better lives in cities. Child mortality in India is down by almost five-sixths.

It could reasonably be argued that nothing this good has ever happened before in human history. And India and China's growth appears far from over.

So sure, the Washington Consensus didn't boost Latin America into the ranks of rich countries. And the neoliberal reforms in the former Soviet Union met with mixed success. But India and China account for more than three times as many people as all of those countries combined. Their sweeping reduction in extreme poverty alone makes neoliberalism a qualified success. Though the free-market approach unquestionably has its shortcomings, it would be wrong to label it "bad economics," as Rodrik does. The truth, as usual, is more complicated.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Noah Smith is a Bloomberg View columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion.

To contact the author of this story: Noah Smith at nsmith150@bloomberg.net.

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