If anything could have dislodged the neoliberal doctrine of freeing the market from the government, you might have expected the coronavirus pandemic to do the trick. Of course, the same was said about the global financial crisis, which was supposed to transform everything from macroeconomic policy to financial regulation and the social safety net.
Now we are facing a particularly horrifying moment, defined by the triple shock of the Trump presidency, the pandemic, and the economic disasters that followed from it. Perhaps these—if combined with a change in power in the upcoming election—could offer a historic window of opportunity. Perhaps. But seizing the opportunity will require a new kind of political-economic thinking. Instead of starting from a stylized view of how the world ought to work, we should consider what policies have proved effective in different societies experiencing similar challenges. This comparative way of thinking increases the menu of options and may suggest novel solutions to our problems that lie outside the narrow theoretical assumptions of market-fundamentalist neoliberalism.
The pandemic has exposed the fallacies of the neoliberal paradigm. The market could not keep businesses running or people working.
Neoliberalism implies a one-size-fits-all set of policy solutions: less government and more market, as if the “free market” were a single equilibrium. To the contrary, we know that there have been multiple paths to economic growth and multiple solutions to economic crises in different societies. By recognizing that there is not one single path to good outcomes, that real-world markets are complex human constructions—governed in different places by different laws, practices, and norms—we open up the possibility that policies that seem objectionable in light of neoliberal abstractions may deliver high performance along both social and economic dimensions.
We know about these possibilities from the work of economic sociologists, who stress the political, cultural, and social embedding of real-world markets. From work in comparative political economy, demonstrating how the relationships between government and industry and among firms, banks, and unions vary from one country to another. From political and economic geographers, who place regional economies in their spatial contexts and natural environments. From economic historians, who explore the transformation of the institutions of capitalism over time. From an emergent Law and Political Economy (LPE) movement that aspires to shift priorities from efficiency to power, from neutrality to equality, and from apolitical governance to democracy. And from economists—often villainized as the agents of neoliberalism—who are exploring novel approaches to the problem of inequality and the slowdown in productivity, and show renewed concern with the economic dominance of a few large firms.
The challenge is to bring these insights together.
As a step in this direction, we will propose three core principles of an alternative political economy. We then illustrate these principles by discussing the dynamics of the American political economy, focusing particularly on the rise of “shareholder capitalism” in the 1980s. Finally, we apply the principles to the ongoing national policy responses to the COVID-19 pandemic, comparing the United States to Germany.
We recognize that these principles do not resolve the very real problem of the dominance of business in U.S. politics and the political gridlock produced by this configuration of power. Still, they point in new and urgent directions.
First, then, governments and markets are co-constituted. Government regulation is not an intrusion into the market but rather a prerequisite for a functioning market economy. Critics of neoliberalism often make the case for government “intervention” in the market. But why refer to government action as intervention? The language of intervention implies that government action contaminates a market otherwise free of public action. To the contrary, the alternative to government action is not a perfect market, but rather real-world markets thoroughly sullied with collusion, fraud, imbalances of power, production of substandard or dangerous products, and prone to crises due to excessive risk-taking.
Critics of neoliberalism often make the case for government “intervention” in the market. But why refer to government action as intervention?
Likewise, critics of neoliberalism often adopt the fictional “free market” as a reference point even as they make the case for deviation from it. For example, they follow the standard practice of economists by identifying market failures and proposing solutions to those failures. To be fair, this can be a useful way to see how government action can remedy specific problems, and to assess when action may be helpful or not. But this approach also risks obscuring the fact that market failure is the rule and not the exception. More fundamentally, the government is not a repair technician for a market economy that functions reasonably well, but rather the master craftsperson of market infrastructure.
Thus, governments pacify a territory and centralize the means of violence, making investment safer and trade less precarious. They create ways to write and enforce contracts via the rule of law. They provide public goods like education and transport infrastructure. No neoliberal denies the value of these things.
Beyond these basic functions, governments establish the conditions for the emergence of new markets, provide the architecture to stabilize existing ones, and manage crises to limit damage and facilitate recovery. Historically, governments fostered many of the largest markets, such housing and banking, by designing new market structures that enabled the mass expansion of goods and services. In the case of the housing market, the U.S. federal government created the 30-year fixed interest rate mortgage as the standard mortgage product. It also stabilized the savings and loan industry by creating rules about paying interest on bank accounts and deposit insurance.
In the postwar era, this system helped propel home ownership from around 40 percent to 64 percent. More recently, many policy failures, such as the financial crisis of 2007–2009, occurred because governments shirked their role of making markets work through “deregulation.” Essentially, the U.S. government allowed financial institutions to enter whichever businesses they liked and with little oversight. In the wake of the Great Recession, predictably, the government re-established control and oversight over the banking sector with the Dodd-Frank Act. One of the provisions of that act was to give the Federal Reserve the ability to ask the largest banks to undergo stress tests every year to determine whether or not they could manage a serious downturn.
Governments also support knowledge creation and dissemination and underwrite the cost of innovation in the private sector. They facilitate the organization of market activity by establishing the legal basis for corporations and by setting the rules for fair and efficient trading practices on stock exchanges. A political economy that does not value the role of government along these different dimensions distorts how markets do contribute to society.
Second, real-world political economy hinges on power, both political and market power. Specific forms of market governance—of the kinds we just sketched—do not arise naturally or innocently. They are the product of power struggles between firms, industries, workers, and governments within particular markets and in the political arena. Those with more power and wealth, especially incumbent firms, seek to shape governance in their favor. There is no natural equilibrium point of perfect competition devoid of power, but only a spectrum of power balances between employers and workers, incumbents and challengers, lenders and borrowers, and so on.
For example, we tend to think of labor market regulation as the protection of workers from exploitative employers. But labor market regulation can also protect employers from workers by imposing restrictions on union formation or strike activity. So the balance of power between employers and workers is not inherent to the market, but reflects the historic battles that forged the particular forms of governance in the economy. The fact that there is no “state-of-nature” has important implications for how we analyze labor markets and design policy solutions. For analysis, it means that we should not take any given state as a reference point or a default, but rather try to understand how real-world labor markets are governed, how that governance came to be, and what consequences it has.
Political economy should investigate how political and market power interact. This means integrating multiple levels of analysis, including government, industry, firm, and individuals.
In the United States, for example, the Reagan administration confronted public sector unions by firing air traffic controllers who were on strike, appointing more business-friendly representatives to the National Labor Relations Board, and enacting rule changes that made it harder for unions to win elections and easier for companies to decertify unions. And this in turn emboldened managers to engage in more aggressive anti-union strategies.
For policy, since there is no “power-free” solution but only an infinite variety of power balances, we should not be too shy about turning the dial to recalibrate the balance in the public interest.
So political economy should investigate how political and market power interact. For example, we should not take a firm’s market dominance as a given, perhaps needing some corrective action, but investigate how that dominance might itself reflect political influence and social privilege. Likewise, we should understand the political power of a firm or an industry as more than financial contributions or lobbying because a dominant market position—for example, in transportation or information—can generate influence even in the absence of political activity.
This means that political economy needs to integrate multiple levels of analysis, including government, industry, firm, and individuals. Political scientists cannot understand politics without understanding what is happening at the firm level, and how that shapes what businesses lobby for. Business scholars cannot understand corporate strategy without examining how businesses press for regulatory changes that support their business strategies and how they take advantage of those changes once enacted.
Third, there is more than one way to organize society to achieve economic growth, equity, and access to valued goods and services. The balance of power between government, workers, and firms differs greatly across countries and time. And the different power balances in different countries shape distinctive national trajectories of policies. We can expect that the governing institutions will reinforce the status-quo balance of power, particularly in a crisis. It is rare for any one set of actors to have total control in a society, a condition that would lead to extreme rent-seeking behavior. Instead we see constant contestation between different sets of organized actors but a general balance of power that reflects the dominance of one side or another. One of the most reproduced empirical results from comparative political economy is that the same crisis will beget very different policy responses from societies that have different balances of power between the state, labor, and capital. If one takes a long-run view of economic development in the developed world, one can see that a great variety of these arrangements are compatible with innovation and growth.
There is more than one way to organize society to achieve economic growth, equity, and access to valued goods and services.
Abandoning the neoliberal lens of government versus market and the “one best way” perspective opens up the possibility of a profound rethinking of economic policy that seeks to learn from the great variety of capitalisms that actually exist. One intriguing implication of this understanding is that a new political economy implies a turn toward what is sometimes called the “predistribution agenda.” Redistributive policies take the market allocation of income and wealth as a given and devise ways to moderate the inequalities that markets generate. Predistributive policies focus on how market governance—such as corporate governance, labor regulation, financial regulation, or antitrust policy—affects who benefits from economic activity in the first place. We can learn from the experiences of other societies where different policies and institutions have been tried and found to work more equitably. The government could enact reforms in these areas to give workers a more powerful voice in corporations; push financial institutions to deliver more value for the economy and fewer rents to themselves; shift the balance of power between employers and workers; or constrain market power to benefit both workers and consumers. That would not undermine American capitalism but revitalize it.
To illustrate these three general ideas, consider the case of corporate governance. The standard models assume that firms maximize profits by making the right kinds of investments to produce goods at the lowest prices. But there is a lot of evidence that firms actually favor the stabilization of markets or organizational survival over profits.
Incumbent firms are threatened by the possibility that a disruptive challenger could come along and offer a lower price or a better product, or develop a breakthrough innovation that would render the incumbent’s product obsolete. So they deploy a combination of political strategies, such as lobbying, and corporate strategies, such as alliances and mergers, to insulate themselves from such threats. Their efforts to ensure stability include tactics such as setting industry standards—which could be formal, like technical standards, or informal, like industry-specific codes of behavior. In essence, firms can achieve profits and stability via value creation, rent extraction, or some combination of the two. But if they cannot be sure that they will always be able to outrun the competition, they turn to political and business strategies to ensure that they will survive even if they do not.
This perspective on firm behavior is not only more accurate than a profit-maximization model, but it can account for behavior that cannot be explained by that model. It makes sense of much of what we read in the business news, from U.S. big tech firms that buy out tiny rivals at huge premiums to Japanese firms that hold each other’s stocks rather than optimize their investment portfolios. Hence a political economy perspective can be used to explain the outcomes that policy makers, business leaders, and economists care about most, such as corporate profits, economic rents, wages, and investment.
Moreover, this line of inquiry can be usefully applied to variations across countries, regions, sectors, firms, or time. For example, if we look at the gradual transition of the U.S. corporate governance model from a managerial model in the early postwar era to the shareholder model of today, we uncover a long series of lobbying efforts to change laws and regulations, legal strategies to transform the meaning of those laws and regulations, and business practices to shift corporate governance to deliver higher returns to both shareholders and corporate executives. Hence this case illustrates each of the three principles outlined above: the interpenetration of government and market, the centrality of power, and variations across time and space.
The shareholder value system in the United States reflects the long-term dominance of capital over labor and government. In the shareholder value era, this dominance consistently provided ideological and political support for the policy agendas of firms. For example, financial liberalization beginning in the 1980s allowed the financial sector to take more risks with financial innovation and to break down the barriers between banking businesses, such as commercial banking, brokerage, and insurance. This was all done in the name of making markets more “efficient.” The idea was that financial firms should be able to buy and sell risk of any kind, and this would increase the depth and liquidity of financial markets. Financial firms claimed that they would manage risk because they were the ones who would suffer from any bad investments. In the early 2000s, the financial sector with about 11 percent of employment earned almost 40 percent of all of the profits in the American economy. We now know that they were able to do so not because financial innovation produced efficient capital markets, but because they were able to take huge risks without much oversight.
The shareholder model has fueled the unprecedented rise in U.S. income and wealth inequality since the 1980s.
The shareholder value revolution in the United States featured a set of tactics that have increased the share of national income to shareholders and decreased the share going to everyone else. In the 1980s, firms bought out other firms, closed plants, and outsourced production, often to foreign countries. In the 1990s, when these tactics had run their course, firms turned to reducing their layers of management. They fired a whole generation of managers and pushed managers who remained to work 24/7. They invested heavily in computer technology to increase control over remaining employees. Work became more insecure not just for lower-skilled workers but for everyone.
In the past twenty years, firms have constructed global supply chains, thereby making outsourcing more profitable and propelling the rise of China as a manufacturing power. U.S. firms have engaged in mergers with their competitors, raising market concentration. The shareholder model has fueled the unprecedented rise in U.S. income and wealth inequality since the 1980s. It has done so by rewarding top managers with shares, giving them an incentive to manipulate share prices as a major goal of corporate strategy. In the past ten years, American firms have spent massive amounts of money buying back their own shares to raise stock prices.
The COVID-19 pandemic has exposed the fallacies of the neoliberal paradigm especially starkly. It highlights the fact that the government—and not the market—is the only viable solution to some of our greatest challenges. The private sector and market incentives could not manufacture, procure or deliver the key supplies needed to combat the virus, including tests, ventilators, or personal protective equipment. The market could not keep businesses running or people working. And the private sector was not willing or able to make the massive investments required to design new therapies or to develop a vaccine.
Moreover, those countries that had gone the furthest with neoliberal policy reforms—such as the United States and Britain—were the least well equipped to manage the public health and economic crisis. As stressed above, a society with a particular balance of power between labor, capital, and the government is likely to produce policy solutions to a crisis that benefit those who dominate in that society. So what would that mean for the current crisis? Consider a brief comparison of the United States and Germany. We choose the United States as a country where capital dominates over labor and the state and Germany as a country with a more even balance of power among these actors.
We readily concede that the quality of the top leadership in the two countries explains part of the enormous gap between the two countries in containing the pandemic, caring for the ill, and supporting businesses and workers through the economic downturn. By the end of September, the United States had 2,203 cases and 92 deaths per 100,000 people, whereas Germany had 355 cases and 17 deaths. Yet there is also a strong propensity to favor capital over labor in the U.S. government’s approach. The Trump administration’s initial reluctance to confront the pandemic and its later eagerness to reopen the economy revealed a preoccupation with the performance of the stock market and continuation of business activity, even at the expense of the health of workers and citizens.
Meanwhile, the fragmented nature of U.S. health care provision and insurance impeded the delivery of health care services. Some people did not seek care because they were not insured. Others lost health insurance coverage when they lost their jobs. Moreover, the government had excluded huge segments of the population from the circle of care via the carceral state: locking them up in prisons and jails, threatening them with deportation, or throwing them out on the street. Just as before the crisis, the U.S. healthcare system provided less access at a higher cost relative to Germany and most other advanced countries.
The U.S. federal government’s economic packages have favored businesses, especially large businesses. The United States lacked strong public-sector financial institutions or the ability to coordinate private sector financial institutions that could have enabled it to support businesses more effectively. The U.S. government allocated its rescue funds through the Small Business Administration and the private banking system, but this led to inefficiency, inequity, and fraud. The lack of paid leave and job security schemes meant that the stimulus package had to work through corporate subsidies and unemployment insurance rather than job protection.
The U.S. unemployment rate jumped from 3.5 percent in February to 14.7 percent in April, while the German rate rose from 4.7 percent to 5.5 percent. Congress provided an extra $600 per week unemployment benefit under the CARES Act, which passed in late March, but those benefits expired at the end of July. And Congress has not given state governments the support they need to preserve public services. The Federal Reserve provided massive liquidity to financial markets and purchased various kinds of financial assets to support asset prices. The rebound of the stock market can only be read as the government siding with shareholders over everyone else. Business has been protected while citizens have borne the brunt of the virus and the economic downturn.
The country with a power base that favors workers and citizens more generally over firms appears to have responded to the crisis more effectively than the United States.
In contrast, the German government addressed the spread of the virus rapidly with a coordinated program of social distancing, testing, and contact tracing. The German health system had a higher reserve of supplies, an ample supply of intensive care units, and it was able to ramp up testing and ICU capacity quickly. Germany already had a short-term work (Kurzarbeit) program, which had operated successfully through the global financial crisis, to pay most of the lost wages so that firms could retain workers through a downturn. So, the government simply reinforced this program for the new crisis. The government also coordinated with the federal development bank (KfW), the public state-level public banks (Landesbanken), and the commercial banks to mobilize its program of state-guaranteed loans for business. So far the country with a power base that favors workers and citizens more generally over firms appears to have responded to the crisis more effectively than the United States, where the protection of firms and support for the stock market were the priority policy goals.
This example illustrates that policy choices reflected the assumptions leaders made about how the political economy works, and who and what should be promoted and protected. Their options were also powerfully shaped by pre-existing modes of market governance and policy legacies. While both sets of choices may eventually produce an economic recovery, they do so by quite different means, with different values, and with different distributional consequences. We expect that U.S. citizens, particularly those in the bottom 40 percent of the income distribution will experience the negative effects disproportionately, while Germany will encounter less economic dislocation and long-run impact for those most at risk.
Americans have lower trust in government than Germans. Political scientists argue that this lack of trust plays out in supporting the status quo that favors business over everyone else. But we know from polling that Americans favor a wealth tax on the very rich and many of the social programs standard in Europe such as universal health care and a more extensive social safety net. In the coronavirus crisis, polling has shown a great deal of support for government action to support the economy. We should take advantage of that support to search for the best ideas, not an illusory “one best solution.”