a car with no steering wheel and no road map:Neoclassical discourse and the case of India1
Matthew McCartney (SOAS, University of London)
© Copyright 2003 Matthew
Neoclassical economics is based, as is any school of economics on
certain assumptions. It is my
contention here that too often these assumptions have served to narrow its
analytical perspective. In particular
the analysis of economic liberalisation has been limited to accounts
chronicling its implementation.
Analysis is very seldom concerned with the practical impact on issues
such as productivity, employment, social stability, etc. This is examined here with particular
reference to India in its ‘liberalising’ period after 1991.
Economics and Assumptions
Assumptions make life easier. In
partial equilibrium analysis ceteris paribus2 allows
a researcher to turn his attention from a bewildering array of possible
general equilibrium interactions and reach a commonsense conclusion. A demand curve slopes downwards; a higher
price of apples will reduce the quantity consumed. There is no pressing reason to explain the
endlessly complex interactions with markets for oranges, bananas, guavas,
…. Assumptions in economics offer
simplification; they give to a question a parsimonious structure, enabling
the researcher to focus on the heart of the problem. Altering the assumptions and gauging the
impact on the conclusions enables the robustness of the model to be
analysed. Even in a patently
unrealistic abstraction, such as the Walrasian
General Equilibrium model, assumptions provide a benchmark. Once we drop the assumption of perfect
information we can analyse the impact on welfare of asymmetric information in
exchange; of externalities and imperfect competition in production. Properly utilised the Walrasian
General Equilibrium provides us a gateway to the rich analysis of Stiglitz, Akerlof et al.3
In neoclassical economics assumptions obscure underlying economic
processes. Results may be totally
contingent on an assumption included for mathematical convenience. Ultimately assumptions may serve to
distract the researcher from the heart of the issue.
“Theories can therefore be judged by their assumptions to some extent, if one
has an intelligent taxonomy of assumptions.
A theory may well draw power from ‘unrealistic’ assumptions if those
assumptions assert, rightly, that some factors are unimportant in determining
the phenomenon under investigation.
But it will be hobbled if those assumptions specify the domain of the
theory, and the real world phenomena are outside that domain.” (Keen, 2002,
Efficient Growth (By Assumption)
By assumption individuals are rational and exchange is voluntary. Under perfect competition, consumption will
be distributed intertemporally efficiently. Profit maximising firms will utilise these
available resources and optimise investment decisions. The growth path over time reflects
preferences of individual agents, hence by assumption it must be efficient.
Economic reform (comprising stabilisation and structural adjustment) is based
on this assumption of efficient growth.
The two components are intrinsically linked. Stabilisation ensures that growth will be
sustainable, reducing inflation, government budget deficits and any trade
stabilisation is achieved, the reform process (synonymous with
liberalisation) is simply an accelerator.
Structural adjustment comprises all those policies that may interfere with
optimising decisions by consumers and firms.
Tariffs must be reduced to align domestic with world prices. Privatisation will ensure that decisions
are made by rational profit maximising entrepreneurs. Removal of minimum wage legislation enables
agents to make voluntary and hence mutually beneficial exchanges in the
labour market. There is no question of
steering the economy, simply of speeding up (deepening is the typical
metaphor) or slowing down the process of transition from dirigisme to a free
Neoclassical analysis typically focuses nearly exclusively on the depth, pace
and implementation of reforms. A
typical example is the slowdown in economic growth in India after 1996. There is a broad consensus among
neoclassical economists on the need for a ‘Second Generation’ of reforms to
deepen those launched in 1991, to liberalise those areas hitherto neglected –
especially the labour market and privatisation. Growth has stalled, hence the accelerator
Liberalisation, Means and Ends
Much of the intellectual
artillery for the neoclassical counter-revolution in economics was derived
from close study of the experience of countries that had pursued strategies
of import substitution in the post-war period.5 Industry was found to be high cost, capital
intensive and hence generating little employment. Far from achieving self-sufficient industrialisation,
such countries continued their dependence on imports of capital goods and
inputs. The counterpart of
industrialisation was a general discrimination against agriculture.
This type of analysis provided important antecedents for the shift to
strategies of outward orientation often as intrinsic parts of structural
adjustment programmes from the 1980s onwards.6
However the widespread adoption of the neo-liberal agenda has not seen a
complementary pattern of analysis.
The success of ‘reform’ is not typically measured in terms of
employment, inequality, and growth. Rather,
“The problem was that many
of these policies became ends in themselves, rather than means to more
equitable and sustainable growth. In doing so these policies were pushed too
far, too fast, and to the exclusion of other policies that were needed.” (Stiglitz, 2002, p53).
A good example of the
neoclassical evaluation of liberalisation in India is provided by Ahluwalia7
(2002) and Bajpai8 (2002). Ahluwalia makes the claim that,
“we consider the cumulative
outcome of ten years of gradualism to assess whether the reforms have created
an environment that can support 8 percent GDP growth, which is the
government’s target.” (Ahluwalia, 2002, p69).
Ahluwalia retreats into a typical twofold analysis,
considering first whether growth is sustainable – examining as a consequence
trends in the fiscal deficit, current account deficit and foreign exchange
reserves. Then cataloguing how far
liberalisation has been implemented - tariff reductions, degree of
integration with the world economy9, removal of price controls,
Bajpai (2002) follows the same track. He compiles a review of liberal policy
reforms – devaluation, current account convertibility, trade liberalisation,
encouraging FDI inflows, opening the capital market
to portfolio investment, permitting domestic companies access to foreign
capital markets. Bajpai
does not even make passing reference to the impact of these ‘reforms’ in any
other context than the change in integration with India and the world
economy. He notes, over the course of
the 1990s that the weighted average tariff fell from 90 to less than 30%,
foreign investment increased from 0.1 to 1% of GDP, the share of trade
increased from 18 to 30% of GDP.
The underlying assumptions of voluntary exchange and rational optimising
individuals mean that it must by definition be the case that the level of
growth reflects individual preferences and hence maximises welfare in a free
market. The successful outcome of
reform and the degree of implementation of liberalisation are collapsed by
a-priori assumption into the same meaning.
There is, it is assumed, no need to examine the impact of liberalisation on
the productivity and level of investment, the degree of social cohesion,
political and social stability, the level of spending on R+D,
the diversification of exports into more dynamic industrial sectors.11
Liberalisation, Reform and a Roadmap
There is no roadmap
because by assumption neoclassical economics does not admit the possibility
of an alternative.
Rodrik (2000) argues to the contrary that
integration with the world economy cannot substitute for a development
strategy. Development is increasingly
viewed as synonymous with global integration and with trade and investment
being used as yardsticks for evaluating government policy. In actual fact ‘integration’ may crowd out
suggests globalisation should be evaluated in terms of the needs of
development, not vice-versa.
It is clear, that although
there exists a near consensus on the positive relationship between openness
“there is a dirty little
secret in international trade analysis.
The measurable costs of protectionist policies – the reductions in
real income that can be attributed to tariffs and import quotas – are not all
that large.” (Krugman, 1995, p31).
And there is another fact often forgotten.
Liberalisation and integration are not concerned solely with the
removal of controls and unwinding of government intervention. They also have demanding institutional
notes that to comply with the full panoply of WTO
obligations (customs, phyto and sanitary,
intellectual property rights, etc.) would cost the typical LDC $150m. The
small gains from trade noted by Krugman are
undoubtedly offset by the potentially enormous gains from an alternative –
such as basic education for girls12.
Liberalisation, Implementation and Crisis
The neo-liberal discourse has not reacted to crises by evaluating their underlying
assumptions, but instead adding layers of complexity to preserve them. To the concern with the pace and depth of
implementation have been added other considerations.
Liberalisation in the Southern Cone countries of Latin America in the early
1980s, saw rapid capital account liberalisation and large budget/ trade
deficits. This generated huge capital
inflows, consequent currency overvaluation, deindustrialisation, debt
accumulation and inevitable collapse.
There was no fundamental attention to assumptions in response, no
puzzling that in the case of Chile at least the vast bulk of the accumulated
debt was private13 so could not by definition be considered a
problem. The concept of sequencing
of liberalisation emerged, specifically that a fiscal deficit should be
corrected before the capital account is liberalised. With a similar crisis in Asia in 1997,
sequencing implies prudential regulation of the banking sector before capital
The economic disintegration of Russia after 198914 despite a bold
pursuit of liberalisation (price reform, privatisation, abandonment of
planning) and rapid democratisation generated much discussion of the relative
merits of gradualism over shock therapy and the importance of institutions. An evident example is that privatisation
without a functioning legal system in the midst of an economic collapse, will
generate compelling incentives for asset mining among managers and workers.
Analysis of liberalisation can be likened to driving a car with no steering
wheel – there is only one path of reform (from dirigisme to a free market),
the only item of control is the accelerator (the speed and depth of
implementation), and there is of course no road map (there is no
alternative). To extend the analogy (too
far), even at its worst moments, when neoclassical theorising careers through
red lights – in the Southern Cone countries in the 1980s, in Russia in the
1990s there is no critical evaluation of underlying assumptions, only ever
more convoluted refinements to preserve them.
1. Grateful thanks to Ashwin and Alan for
2. Other things being equal.
3. See for example Stiglitz (1986).
4. Private sector induced trade deficits, representing an excess of (optimal)
private sector investment over (optimal) private sector savings reflect
efficient decisions of optimising consumers so do not represent a
5. For the case of India see Bhagwati and Desai
(1970), Bhagwati and Srinivasan
6. The experience of East Asia may have been wrongly interpreted as one of
‘outward-orientated’ free trade rather than a strategy of export
promotion. The latter may imply an
increase in government intervention through a mechanism such as export
7. Finance Minister in 1991-6, the Congress Government which launched the
first generation of liberalising reforms.
8. One of the famously influential American-based non-Resident Indian
economists who have done so much to promote the agenda of liberalisation in
India over the 1990s
9. Exports plus imports as a share of GDP and level of Foreign Direct
10. There is momentary concern with other potential determinants of growth,
infrastructure provision and education, but this does not detract from the
primary thrust which is concerned not with ‘an environment to support eight
percent growth’ but the sustainability and implementation of liberalisation.
11. See variously Athukorala and Sen (2002) Ch 7, Rodrik (1999),
Fosu (1996), Barro (1991)
etc for discussions of these issues and their positive role on economic
12. See Sen (1999).
13. Unlike Argentina the public sector budget was in balance.
14. Under IMF tutelage in the 1990s industrial
output declined by a larger share than during the whole of the Second World
M.S. (2002), ‘Economic Reforms in India Since 1991: Has Gradualism Worked?’ (Journal
of Economic Perspectives, 16:3).
Bajpai, N (2002), ‘A Decade of Economic Reforms in
India: The Unfinished Agenda’ – (Centre for International Development,
Harvard University Working Paper No.89).
Barro, R (1991),
‘Economic Growth in a Cross Section of Countries’ (Quarterly Journal of
J.N and P.Desai (1970),
‘India: Planning for Industrialisation, Industrialisation and Trade Policies
since 1951’ (Delhi, Oxford University Press).
_____ and T.N.Srinivasan (1975), ‘Foreign Trade
Regimes and Economic Development: India’, (Delhi, Macmillan).
Fosu, A.K (1996),
‘Primary Exports and Economic Growth in Developing Countries’ (World
S (2002), ‘Debunking Economics: The Naked Emperor of the Social Sciences’,
(New York: Pluto Press).
Krugman. P (1995), ‘Dutch Tulips and Emerging
Markets’ (Foreign Affairs, July/Aug).
Rodrik, D (1999), ‘Where Did All The Growth Go?
External Shocks, Social Conflict, and Growth Collapses’, (Journal of
Economic Growth, 4).
_____ (2000), ‘Can Integration into the World Economy Substitute
for a Development Strategy (World Bank EBGDE
European Conference, June 26-8th).
J.E. (1986), ‘The New Development Economics’, World
Development, 14 (2).
_____ (2002), ‘Globalisation and its Discontents’, (London: Penguin).
Matthew McCartney, “Driving a car with no steering
wheel and no road map: Neoclassical discourse and the case of India”,
post-autistic economics review, issue no. 21, 13 September
2003, article 5, http://www.paecon.net/PAEReview/issue21/McCartney21.htm