Senior Fellow/Associate Professor, School Deputy Director - Research
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Global economic leaders must be careful not to blur the distinction between post-war Keynesian multilateralism and neoliberal multilateralism, Wesley Widmaier writes.
In Angela Merkel’s keynote address at Davos, she revealed the limits of current conventional wisdom.
“There is a new approach that we see in the world today, an approach that harbours doubt as to the validity of the international system,” she said, worrying that “multilateralism is under threat”. However, the problem may not be a lack of support for multilateralism but the nature of the prevailing neoliberal conventional wisdom.
‘Conventional wisdom’ was famously defined by the economist John Kenneth Galbraith as ideas that are accepted because they are acceptable. What matters is less that such ideas are right or wrong than that they are respectable or familiar.
They form the basis of national interests and shape a state’s beliefs about its needs – telling them who they are and what they want.
Over the early post-war decades, the global conventional wisdom encompassed a ‘Keynesian multilateralism’ amongst nations. This combined support for financial regulation, fiscal activism, and wage growth. Working through institutions like the International Monetary Fund and World Bank, and by providing bilateral assistance where needed, this Keynesian era was marked by sustained growth. However, Keynesian multilateralism also had its faults. The order permitted an acceleration of inflationary wage-price spirals – a vicious cycle whereby an increase in wages leads to an increase in prices, and vice versa. Building in intensity, these spirals led to much societal backlash – not least in Germany, where memories of interwar inflation remained strong.
Then came the rise of a new conventional wisdom in the early 1980s, marked by support for a ‘neoliberal multilateralism’. In this view, sustained growth required multilateral support for financial openness, fiscal restraint, and central bank vigilance against revived inflation.
Instead of wage-price spirals, the neoliberal order ran on asset-price bubbles – marked by vicious cycles whereby expectations of higher asset values proved self-fulfilling, as speculative manias would fuel bubbles that always eventually ‘popped’. Nevertheless, investor euphoria would often recover and move to the next focus, sustained by central banks and multilateral institutions like the G7 and G20, as these supported policies meant to bail out firms that were seen as ‘too big to fail’.
One should not, however, dismiss this neoliberal multilateralism out of hand. It delivered decades of sustained growth. Its most famous supporters came from the political right – figures like US President Ronald Reagan, UK Prime Minister Margaret Thatcher, and West German Chancellor Helmut Schmidt. Yet, supporters also emerged on the left, spanning US President Bill Clinton to UK Prime Minister Tony Blair through US President Barack Obama and UK Prime Minister Gordon Brown to German Chancellor Angela Merkel.
Both sides shared a common view that, in the absence of wage increases, asset-price increases provided a means to economic growth and greater tax revenues that could support a progressive agenda.
This was not an implausible idea, and it worked for a time. However, it was not sustainable.
The flaw in the model was that it rested on the acceptance of long-run wage stagnation – slow growth in wages relative to the rest of the economy – mitigated by sustained asset-price inflation.
In the US, for example, wages have been flat since the 1980s. Growth, on the other hand, has been sustained by consumer borrowing across a variety of settings: consumer credit, student loans, and – most precariously – home equity loans, which contributed to the Global Financial Crisis (GFC) in 2008.
To be sure, the aftermath of the GFC would see a brief return to Keynesian support for fiscal and monetary activism, as a well as the use of ‘macroprudential’ regulation to discourage excessive risk-taking.
However, the conventional wisdom in support of neoliberal multilateralism proved surprisingly enduring. The infusion of post-2008 liquidity resulted in an apparent recovery of aggregate growth. Looking beneath the surface, however, growth in employment proved to be illusory. For example, notwithstanding a 3.9 per cent unemployment rate today, US labour force participation remains at 63.1 per cent – well below 66 per cent pre-crisis levels.
Into 2016, the US political establishment was blinded by a conventional wisdom which held that the economy had recovered, helping to explain the rise of Trump.
Similar neoliberal myopia characterises the debate in Davos today.
“Have we actually learned the lessons of history?” asked Merkel. “We haven’t really… I will come out strongly in favour of a multilateral order.”
Yet, like Clinton, Blair, and Obama before her, the German chancellor underrates some real limits to neoliberal multilateralism. Indeed, one could argue that bears considerable responsibility for the tensions of the past decade.
The paradox of Merkel’s question about “the lessons of history” may be that she does not truly appreciate what made post-war growth possible. The Keynesian multilateralism of the early post-war decades was fundamentally different from the neoliberal multilateralism that Merkel supports.
To the extent that the conventional wisdom we have seen at Davos pits a neoliberal multilateralism against a global populism, we are ironically likely to see more populism.
Learning the lessons of history might therefore require a broadened conventional wisdom. It must recognise the long-run costs of financial openness, and the potential – particularly given the weakness of labour – for wage-price increases to reduce not only inequality but also the appeal of reactionary populism.
Put differently, where multilateralism swung too far in the direction of favouring wage increases in the 1970s, it has swung too far in the opposite direction in the 2010s – and a correction to the conventional wisdom is well-overdue.
This piece was first published at Policy Forum, Asia and the Pacific’s platform for public policy analysis and opinion.