From Liberalism to Neoliberalism

Neoliberalism had problematic consequences in its support of free trade. The basic doctrine is correct: countries that lower trade barriers with one another will see markets and efficiency expand, leading to higher aggregate incomes for all parties concerned.

by Francis Fukuyama

Following excerpts adapted from author's new book, Liberalism and Its Discontents published by Profile Books

One of the critical domains in which liberal ideas were taken to extremes lay in economic thought, where liberalism evolved into what has been labeled “neoliberalism.”

Neoliberalism is often used today as a pejorative synonym for capitalism, but it should more properly be used in a narrower sense to describe a school of economic thought, often associated with the University of Chicago or the Austrian School, and economists like Milton Friedman, Gary Becker, George Stigler, Ludwig von Mises, and Friedrich Hayek, who sharply denigrated the role of the state in the economy, and emphasized free markets as spurs to growth and efficient allocators of resources. These economists, many of whom were awarded Nobel Prizes, provided a highbrow justification for the pro-market, anti-statist policies pursued by Ronald Reagan and Margaret Thatcher in the 1980s. These policies were continued by center-left politicians like Bill Clinton and Tony Blair, who promoted the deregulation and privatization of their economies in ways that laid the ground for the rise of populism in the late 2010s. This pro-market consensus was absorbed by a whole generation of young people, many of whom were subsequently disillusioned by the great financial crisis of 2008, the 2010 euro crisis, and subsequent economic travails.

Francis Fukuyama

On a more popular level, neoliberalism was allied to what Americans label libertarianism, whose single underlying theme is hostility to an overreaching state and belief in the sanctity of individual freedom. Libertarians joined hands with Chicago-school economists in their hostility to state regulation of the economy, and their belief that governments would only get in the way of dynamic entrepreneurs and innovators. But their belief in the primacy of individual freedom led them to oppose state action in social matters as well. They were highly critical of the large and seemingly ever-expanding welfare states that had been created in most liberal democracies over the decades, and disapproved of state efforts to regulate personal behaviors like drug use and sexuality. Some libertarians believed it was simply up to individuals to take care of themselves. The more thoughtful ones argued that social needs could be better met through private action than through large state bureaucracies, whether by the private sector itself or in civil society (that is, non-profit organizations, churches, voluntary groups, and the like).

The Reagan-Thatcher neoliberal revolution was grounded in, and solved, some real problems. Economic policy in the developed world has swung between extremes over the past century and a half. The nineteenth century was the heyday of unregulated market capitalism, with state intervention playing little role in protecting individuals from a cutthroat form of capitalism, or dampening the impact of the recessions, depressions, and banking crises that occurred with great regularity.

This all changed by the early twentieth century. Beginning in the 1880s, Progressive Era reformers put into place the foundations of a regulatory state, beginning in the United States with the Interstate Commerce Commission to regulate the railroads that were proliferating everywhere. The Sherman, Clayton, and Federal Trade Commission Acts gave the government powers to limit the growth of monopolies, and the severe banking crisis of 1908 led to the creation of the US Federal Reserve system. The Great Depression spawned a plethora of regulatory bodies like the Securities and Exchange Commission, as well as the Social Security Administration to organize pensions. The crisis of global capitalism in the 1930s gave states much greater legitimacy at the expense of private markets, leading to the rise of expansive regulatory and welfare states in Europe and North America.

By the 1970s, the pendulum had swung over to excessive state control. Many sectors of the economies of the United States and Europe were overregulated, and generous commitments to social welfare systems left many rich countries facing exploding debt loads. After experiencing nearly three decades of almost uninterrupted economic growth, the world economy hit a hard stop after the 1973 Middle East War and the quadrupling of oil prices by OPEC. Economic growth crawled to a halt and inflation soared around the world as the global economy tried to adjust to higher resource prices. The impact was most devastating in the developing world, where money center banks recycled oil-producing country surpluses into debt that countries in Latin America and sub-Saharan Africa used to maintain standards of living. This proved unsustainable; one country after another defaulted on their sovereign debts and experienced collapsing employment and hyperinflation. The cure for these problems undertaken by international financial institutions was that prescribed by the Chicago School: fiscal austerity, flexible exchange rates, deregulation, privatization, and strict control over domestic money supplies.

In the United States and other developed countries, deregulation and privatization had beneficial effects. The prices of airline tickets and trucking rates began to fall as states pulled back from the pervasive price controls they had imposed. Margaret Thatcher’s most heroic moment was in her confrontation with Arthur Scargill and the coal-miners’ union: Britain had no business mining coal at that point in its economic development, nor in owning companies like British Steel or British Telecom, which were more efficiently run by private operators. Britain’s economic revival after a dismal decade, the 1970s, was due in large measure to neoliberal policies.

But the neoliberal agenda was pushed to a counterproductive extreme. A valid insight into the superior efficiency of markets evolved into something of a religion, in which state intervention was opposed as a matter of principle. Privatization was pushed, for example, even in cases of natural monopolies like key public utilities, leading to travesties like the privatization of Mexico’s TelMex, where a public telecommunications monopoly was transformed into a private one and facilitated the rise of one of the world’s richest men, Carlos Slim.

Some of the worst consequences were felt in the former Soviet Union, which fell apart right at the moment when neoliberal ideology was at its peak. Socialist central planning had been rightly discredited by the poor performance of communist economies all over the world. There was a belief among many economists, however, that private markets would form spontaneously once central planning was dismantled. They failed to understand that markets themselves function only when they are strictly regulated by states with functioning legal systems that have the capacity to enforce rules concerning transparency, contracts, ownership, and the like. As a result, large chunks of the Soviet economy were gobbled up by clever oligarchs whose malign influence continues to the present day in Russia, Ukraine, and other former communist countries.

Even as it promoted two decades of rapid economic growth, neoliberalism succeeded in destabilizing the global economy and undermining its own success. Deregulation was helpful in many sectors of the real economy, but proved disastrous when it was applied in the 1980s and 1990s to the financial sector. Former Federal Reserve chief Alan Greenspan and other economists at the time believed that the latter would be able to regulate itself. But financial institutions behave very differently from firms in the real economy. Unlike a manufacturing corporation, a large investment bank is systemically dangerous, and can impose huge costs on the economy as a whole if it takes excessive risks. This is what the world saw with the collapse of Lehman Brothers in September 2008, when thousands of counterparties around the world found themselves unable to meet their own obligations because of their entanglement with Lehman. The global payments system froze up and was rescued only by massive injections of liquidity by the US Federal Reserve and other central banks. If ever there was a case to be made for the necessity of a large, centralized state institution, this was it. Libertarians forgot that the absence of a central bank and reliance on the gold standard prior to the Federal Reserve Act of 1919 had seen massive periodic financial crises like the one that shook the US in 1908.

Indeed, American neoliberals were hoist, so to speak, with their own petard. From the 1980s onwards the US Treasury Department and institutions like the World Bank and IMF had been advising countries around the world to open up their capital accounts and let investment funds flow freely. They were seeking to undo the capital controls that had been instituted in the wake of the banking crises of the 1930s. From the end of the Second World War up through the 1970s, the global financial system had been highly stable. As liquidity was subsequently encouraged to move unhindered across international borders under the influence of neoliberal ideas, financial crises occurred with alarming regularity. This began with the sterling and Swedish banking crises in the early 1990s, the Mexican peso crisis of 1994, the 1997 Asian financial crisis, and the Russian and Argentine defaults in 1998 and 2001. This process culminated in the 2008 with the US subprime crisis, where global capital had rushed into a poorly regulated American mortgage market and devastated the real economy when it flowed out again.

Neoliberalism had problematic consequences in its support of free trade. The basic doctrine is correct: countries that lower trade barriers with one another will see markets and efficiency expand, leading to higher aggregate incomes for all parties concerned. The rise of East Asia in the late twentieth century and the dramatic fall in global poverty in that period would not have been possible without expanding trade.


Francis Fukuyama is the author of The End of History, The Great Disruption, Our Posthuman Future, State Building,After the Neocons, The Origins of Political Order and Political Order and Political Decay. All have been hugely influential international bestsellers, translated and published in many languages. He is Olivier Nomellini Senior Fellow at the Freeman Spogli Institute for International Studies, Stanford.