How to Solve the European Economic Crisis: Challenging orthodoxy and creating new policy paradigms
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This paper seeks to understand the processes of paradigm shifts in economic ideas and policy. We begin with an explanation of the concept of a "politico-economic paradigm", with reference to the theory and history of the two paradigm shifts occurring in the 20th century. We then examine how the second of these, the shift to "neoliberalism", occurred. The final section assesses the degree to which economic and political conditions since the financial crisis offer an opportunity for a new paradigm shift away from neoliberalism.
Modern economic history can be roughly split into different eras in which certain sets of ideas have dominated politics and policy. We shall refer to a dominant group of ideas as a politico-economic paradigm. Politico-economic paradigms can exert a powerful influence over academic and media debates, as well as on policymaking institutions, both national and international. Over the last hundred years, Western political economy has broadly experienced two major periods of breakdown and transition from one politico-economic paradigm to another.
The second was from the post-war consensus to neoliberalism, starting with the currency and oil shocks of the early s and the adoption of free market economic policies in the s, ushering in the current period of neoliberalism. Each period of change featured a series of economic and political crises, the failure of orthodox ideas and policies to explain and respond to them, and the resultant replacement of the orthodoxy by a new approach.
A body of literature has sought to understand this change process, influenced by Kuhn's theory of paradigm shifts in the natural sciences. According to this theory, change occurs when two conditions are met: first, a critical mass in the number or importance of "anomalies" which contradict the dominant paradigm, and second, the successful development of an alternative theory that better explains the prevailing evidence.
Lakatos built on these ideas, arguing that changes in science could be seen in terms of "research programmes" that are either "progressive" or "degenerating". In contrast, degenerating programmes persist with old theories and ideas, despite their failure to explain the available evidence, and so eventually abdicate their previous status as progressive programmes. Degenerating programmes can have undue staying power, enjoying an incumbency advantage underpinned by the vested interests of leading scientists. A shift in paradigm only occurs when progressive programmes gather sufficient support to overcome the hold of a degenerating programme and a tipping point is reached, after which the old programme is superseded.
While providing useful heuristics, these theories nevertheless need careful application in the field of economics and public policy, which is fundamentally uncertain and in which hypotheses can never be irrefutably falsified. Economic policy is developed through a process of political choices and "social learning" in which policymakers decide on new goals and methods with only partial reference to academic theory or evidence. The inherent uncertainty of economic prediction and the political nature of policymaking make it easier for degenerating programmes to retain their incumbency advantage, aided by vested interests.
Hall argued that economic policy can exhibit three "orders" of change, increasing in their magnitude: adjustment of an existing policy, change in the policy and change in the goals of policy altogether. Similar patterns of change can be observed in both of the politico-economic paradigm shifts which occurred in the 20th century.
Here, we use the theories described above to set out the key characteristics of the shift process, illustrated by the transition from the post-war paradigm to neoliberalism in the s. The prevailing orthodoxy : Since WWII, rising economic growth and incomes cemented the social democratic consensus into a Kuhnian worldview. Keynesian demand management led to the targeting of full employment as the primary indicator of economic success. By the s, policymakers were placing considerable weight on the Phillips Curve — the apparent trade-off between unemployment and inflation — to guide the management of the economy.
The fixed exchange rate regime of the Bretton Woods settlement and financial regulation provided stable conditions for the growth of international trade. Economic shocks and crisis : The breakdown of the international monetary order in the wake of the US leaving the gold standard led to a deterioration in several countries' balance of payments positions, driving inflation higher. The decision by oil producers to raise oil prices added to the inflationary shock, precipitating recessions.
A long-term decline in the competitiveness of significant industrial sectors and poor industrial relations exposed severe weaknesses in the productive capacity of economies, particularly in the UK. Breakdown and transition in orthodoxy : The phenomenon of stagflation simultaneously high inflation and unemployment contradicted the Phillips Curve, while the failure of policies targeting prices and incomes to control inflation, or currency devaluation to restore competitiveness, left few available policy options within the Keynesian framework.
Overall, a critical mass of Kuhnian anomalies led to the degeneration of the incumbent politico-economic paradigm. An alternative progressive programme emerged, marking itself in opposition to Keynesian collectivism. As politicians and policymakers cast around for solutions to the crisis, the proponents of this new approach seemed to offer an escape from instability. New economic policy : Following continual growth in support from policymakers throughout the s, the elections of Margaret Thatcher in and Ronald Reagan in marked the full-fledged emergence of a new paradigm.
New governments precipitated a third order change in policy, switching the principal object of macroeconomic policy from unemployment to inflation. While monetarism was soon abandoned, the wider neoliberal worldview took hold. The state's economic role was drastically diminished to a guarantor of stable economic conditions, alongside significant reductions in taxes and spending, the deregulation of markets, and curtailment of trade unions.
The Society served as the nexus through which a critique of the post-war settlement and the diverse tenets of neoliberalism were generated, as well as a concerted programme of institution-building and political strategy. To understand the way in which the paradigm shift occurred, it is helpful to disaggregate it into three components or levels:. The neoliberal movement started with an intellectual and academic component through the MPS.
It then built a coherent narrative and policy proposals to spread its ideas, performed by a well-resourced ecosystem of institutions and networks mobilised to influence public debate and political processes. Though the academic level is often thought of as most important to the rise of neoliberalism, the shift was actually weakest there; some neoliberal ideas were powerful but never became hegemonic. It was stronger at the level of discourse and narrative, where it came to dominate the way in which economic analysis and policy were discussed in public debate.
It was only decisive at the level of politics and policy: the election of neoliberal-influenced governments ensured a full paradigm shift. The MPS always stressed the need for the neoliberal intellectual project to be multi-disciplinary. From the start, philosophical, historical, legal, political and natural science concepts were used alongside economics.
Inevitably, this resulted in differing paths of development across disciplines and countries. For example, there was a considerable difference between the first Chicago School of Frank Knight, which had similarities with ordoliberalism in Germany, and the second Chicago School of Milton Friedman, whose more radical critique of the state came to underpin the development of Anglo-American capitalism.
In the US and the UK, Friedman's monetarist theory was joined by a number of other socio-economic theories that spanned disciplines. New Classical economists suggested that macroeconomic models must include rigorous microeconomic parameters that reflected the decision-making behaviours which, in their view, governed human beings and societies. This required a return to neoclassical foundations, eventually emerging in the theory of rational expectations. In game theory, the rational expectations assumption was given a theoretical underpinning that drew on the natural sciences.
Though early game theoretic models appeared only to be applicable in extreme circumstances, their assumptions and theoretical insights were soon adopted by those modelling the behaviour of institutions. Public choice theory condemned the idea of the "public interest" as a subjective hypocrisy used to mask the self-interest of bureaucrats and politicians, suggesting that government should operate a system of incentive structures that would harness the inevitable self-interest of public servants. Theories of regulatory capture used the public choice assumption to conclude all regulators are self-interested.
These insights added up to a coherent whole with a power greater than the sum of its parts. Not only did it provide a counter-narrative to the failures of the mainstream politico-economic paradigm in the s, but the combination of these ideas appeared to offer a more "scientific" analysis of the economy and society than offered by the Keynesian orthodoxy. Moreover, it presented plausible solutions at a time when the previous policy was failing — a result in part of the pleasing inner logic of much of neoliberal thought.
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Importantly, these analyses and their attendant policies were attractively sold as having a universality that would serve different times and places and which allowed for better understanding of economic actors. While hegemonic across politics and policy, it is important to recognise that neoliberalism was never all-encompassing within the academic realm. Whereas in the natural sciences, a Kuhnian paradigm shift will lead to the near-universal adoption of the new theory, this is less likely in the more uncertain social sciences.
The neoliberal framework gradually came to dominate leading economic journals and textbooks, but significant debate remained within disciplines, and in macroeconomics in particular there were accommodations between old and new approaches. In the case of new classical economics, the attempt to change macroeconomics in both theory and practice only led to victory in the latter.
In general, hegemonic change in academia is neither likely nor necessary to generate a paradigm shift in the wider world. For such a shift to occur, sufficient change at an opportune time must be combined with attractive and seemingly coherent concepts and narratives. The MPS members' initial ideas were marked by dispute, contradiction and divergence — but they ultimately led to the emergence of a coherent narrative.
Hayek founded the MPS to create a safe space for those with shared philosophical ideas and political ideals to learn, educate and strive toward a common cause. In doing so, he followed a reflexive model for changing the intellectual and practical elements of a paradigm.
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Academia creates the tools for and legitimises the cause of a political project, which, in turn, influences academia through social learning, morality and values, and material factors, such as increases in funding and other incumbency advantages resulting from a higher profile and greater influence. Two conditions are essential to realising change through this model. First, ideas must form part of a coherent narrative that can be easily shared and adapted without central control. Second, an extensive, well-resourced ecosystem of enabling institutions and networks must be developed.
In the s and s, the MPS coalesced around an opposition to "collectivism", concluding that an increased role for the state in economic and social management was incompatible with individual freedom.
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Recognising that they shared a critique of the new social democratic order, the early years of the MPS were dominated by the development of a statement of aims to act as a focal point for those seeking to move from opposition to proposition. Crucially, this statement of aims is political and defines a clear ideological direction; it is neither an academic nor a technical document, and it does not focus purely on a critique of the incumbent paradigm.
This allowed the statement to provide a clear signal to those with views sympathetic to those of the MPS and a focus for the movement's activities. In doing so, it allowed for the decentralisation of both the development of the intellectual component of a new paradigm and the ecosystem that would bring it into practice. A common narrative based around the MPS statement of aims helped bind the incipient movement together. But it needed an ecosystem of people, networks and institutions to propagate it within the public sphere.
This ecosystem was developed by key individuals with a strong understanding of power and how knowledge is transmitted into action. Its leading figures were Hayek and Friedman, who effectively acted as nodal points, connecting different elements of the ecosystem. This was an elite theory of change that focused on influencing current and future opinion leaders.
The transmission mechanism from ideas to practice started in private via platforms, such as the MPS, that afforded security and limited scrutiny. After building coalitions, many members of the MPS went back to academia, from where they predominantly originated, to promote and develop neoliberal ideas.
Soon, the support of wealthy interests — including the Volker Fund, Relm Foundation, General Electric and DuPont — enabled more meetings, networks and academic work. These resources were soon used to create a new breed of "knowledge professional" located within the new institutional form of the modern think tank — politically partisan and focused on strategic influence as well as policy development. Journalists then provided the means by which neoliberal ideas could enter wider circulation.
By the early s, the neoliberal counter-orthodoxy had organised into a transatlantic network. Its members were well-resourced and mobilised, influencing elite groups, political parties and individuals, seeking out and assimilating allied concepts, and fashioning narratives to appeal to political needs. In doing so, they soon led the critique of the incumbent paradigm as it began to falter in the s. By the late s, this network and its ideas had increasingly populated political parties and government institutions, developing strong networks of individuals that spanned important sectional interests.
This ecosystem created the intellectual conditions for change, ensuring that the neoliberal movement was prepared to capitalise on crisis. The policy impotence of the incumbent post-war paradigm gave the movement its chance. In the end, successive crises both intellectually and politically delegitimised the post-war consensus. But it was the elections of right-wing political parties under Thatcher and Reagan that enabled the political displacement of the post-war paradigm in practice.
Explicitly influenced by neoliberal networks, the Republican and Conservative governments of the s gradually introduced policies of deregulation, privatisation, tax reductions and labour market "flexibility", radically changing the political economy of the US and UK, and eventually, by wider transmission, that of most other Western nations. Meanwhile, changes to the economic curriculum in universities and the adoption of neoliberal assumptions across the field of economic understanding and practice had a deep socio-cultural effect, entrenching the idea that economic and political freedoms can be equated and elevating deregulated markets as the only efficient mechanism for allocating resources.
A crucial result was the acceptance by previously oppositional parties of key aspects of the neoliberal consensus. Consequently, by the end of the s, even the elections of more left-leaning governments did not alter some of the fundamental tenets of either ideas or policy. The shift in economic thinking has often been seen as less pronounced in continental Europe than in the US and UK.
Add to this the rise in income and wealth inequality in most countries, and it is no wonder that the perception of a winner-take-all economy that benefits only elites and distorts the political system has become widespread. Nowadays, both advanced economies like the United States, where unlimited financing of elected officials by financially powerful business interests is simply legalised corruption and emerging markets where oligarchs often dominate the economy and the political system seem to be run for the few. For the many, by contrast, there has been only secular stagnation, with depressed employment and stagnating wages.
The resulting economic insecurity for the working and middle classes is most acute in Europe and the eurozone, where in many countries populist parties — mainly on the far-right — outperformed mainstream forces in last weekend's European parliament election. As in the s, when the Great Depression gave rise to authoritarian governments in Italy, Germany and Spain — and a similar trend now may be underway.
If income and job growth do not pick up soon, populist parties may come closer to power at the national level in Europe, with anti-EU sentiments stalling the process of European economic and political integration. Even in the US, the economic insecurity of a vast white underclass that feels threatened by immigration and global trade can be seen in the rising influence of the extreme right and Tea Party factions of the Republican party.
Economic insecurity and the rise of nationalism
These groups are characterised by economic nativism, anti-immigration and protectionist leanings, religious fanaticism, and geopolitical isolationism. A variant of this dynamic can be seen in Russia and many parts of eastern Europe and central Asia, where the fall of the Berlin Wall did not usher in democracy, economic liberalisation, and rapid output growth. Instead, nationalist and authoritarian regimes have been in power for most of the past quarter-century, pursuing state-capitalist growth models that ensure only mediocre economic performance.
In this context, President Vladimir Putin's destabilisation of Ukraine cannot be separated from his dream of leading a "Eurasian Union" — a thinly disguised effort to recreate the former Soviet Union. In Asia, too, nationalism is resurgent. New leaders in China, Japan, South Korea, and now India are political nationalists in regions where territorial disputes remain serious and long-held historical grievances fester. These leaders — as well as those in Thailand, Malaysia, and Indonesia, who are moving in a similar nationalist direction — must address major structural-reform challenges if they are to revive falling economic growth and, in the case of emerging markets, avoid a middle-income trap.
Economic failure could fuel further nationalist, xenophobic tendencies — and even trigger military conflict. The Middle East remains a region mired in backwardness. The Arab spring — triggered by slow growth, high youth unemployment, and widespread economic desperation — has given way to a long winter in Egypt and Libya, where the alternatives are a return to authoritarian strongmen and political chaos. In Syria and Yemen, there is civil war; Lebanon and Iraq could face a similar fate; Iran is both unstable and dangerous to others; and Afghanistan and Pakistan look increasingly like failed states.
In all of these cases, economic failure and a lack of opportunities and hope for the poor and young are fuelling political and religious extremism, resentment of the west and, in some cases, outright terrorism.