By Simon Wren-Lewis

The collapse of Carillion had some important implications for public sector outsourcing, as I discussed here, but I tend to agree with Will Hutton that the real lessons lie elsewhere. He writes

“While some public sector delivery is outstanding, notably in parts of the NHS, the general pattern is more patchy. It is for this reason that governments for decades have been contracting the private sector to deliver goods and services. Trying to extend that principle is not unreasonable if high-quality private sector partners step up to the mark: the problem is they are in such short supply.”

In other words the problem is not so much with outsourcing, if sensibly done by a government that does not automatically think private is best and a civil services able to write good contracts and effectively monitor quality. The problem is with the poor quality of so much British capitalism. Carillion is not just one bad apple, of course: this is a lesson that should have been learned from the financial crisis, and RBS in particular.

But how can that be, when the market ensures that only the most efficient firms survive? That idea, that the market ensures that only the most efficient prosper, is a central message of neoliberal ideology, and it has held UK and US governments under its sway since the time of Thatcher and Reagan. But that ideology contains a large and deep internal contradiction, which applies particularly to large firms like Carillion. To see what that contraction is, we need to talk about ordoliberalism and Ronald Coase.

Ordoliberalism is widely known as the German version of neoliberalism. It too celebrates the benefits of the market. It, like neoliberalism, ignores many of the failures of markets that Colin Crouch eloquently outlines and which economists spend a lot of time studying. But ordoliberalism does recognise one potential problem with their market ideal which neoliberalism ignores, and that is monopoly. Crouch makes a similar distinction in talking about market-neoliberals and corporate-neoliberals.

This distinction is important for reasons that go way beyond the textbook problem with monopoly: that prices are too high and output is too low. To see why it goes beyond that we need to turn to Ronald Coase. He was a British economist who subsequently worked at Chicago. His first major article was”The Nature of the Firm” written in 1937 which introduced the concept of transaction costs to explain the nature and limits of firms. The key point that Coase made relevant for our discussion is that, in theory, much of what firms do could instead be done by markets. For a non-economist this probably sounds strange, so I will briefly try and explain the idea.

In principle the activities of any firm could be duplicated by all its employees, including managers, becoming self employed. The worker who worked for a firm would become a self employed person who signed a contract with the self-employed manager. Furthermore, the self employed manager would not have to work with a fixed set of self employed workers, but for each task they could create a market for the task which any self employed person could bid to fulfil.

Coase asked why we have firms rather than this more market based setup. His answer is transactions costs. A typical worker employed in a firm has to do whatever (within reason) a manager asks them to do. This can vary, often at very short notice, depending on the needs of the firm. Replacing this with a large number of specific short term contracts would be very inefficient, because it takes time to write and read contracts (transactions costs). You could add search costs and many other costs that make the self employed contracting model normally inefficient.

You can see exactly these tensions, between the advantage of the market versus internalising activities within a firm, played out when a firm decides to outsource any of its activities. But these tensions have a darker side. To what extent have firms internalised the market so that they can exploit customers (traditional monopoly), exploit workers (if one large firm is the only potential employer for many workers i.e. monopsony), or as a vehicle for managers to exploit shareholders.

There are two paths you can travel once you recognise all this. The first, and more ordoliberal, is to distrust monopoly of any kind, and be highly skeptical of large firms and their creation through mergers. The second is to assume that firms are always right, and that large firms exist simply because they are more efficient at doing what they do than the same firm broken up. Given the darker side mentioned above, there is no logical reason to take the second path. Skepticism about large firms is the right path to take. The second path, where you presume that there are always good reasons why large firms exist, makes no logical sense, unless your goal is for whatever reason to defend these large firms. It is the path that neoliberalism took.

Will Davies has a fascinating paper of how ideas about the virtues of competition, and the need to break up monopolies, changed within the University of Chicago from the 1930s until the 1980s under the influence, among others, of the work of Ronald Coase. It shows how many of the leading actors during that period chose the second path. Economics is rich enough that, if they so wish, an economist can always invent reasons why monopolies might be efficient, and so earn lucrative fees for so doing.

Thus neoliberalism that might have started as extolling the virtues of the market ends up as “a consultancy racket, in which corporations purchase complex models to justify their chosen strategy”, to quote Will Davies more recently. This is what I meant when I wrote back in 2016.

“It is important that those who use the term neoliberalism today recognise this contradiction. It does not mean that using the term neoliberalism to describe the dominant ideology is wrong, but it is a mistake to assume the ideology has not be moulded/adapted/distorted by those in whose interest it works. These changes have made it intellectually weak at the same time as making it politically strong.”

There are important mistakes that those opposing neoliberalism can make if they do not see this point. They involve opposing anything your opponent appears to favour. Thus, for example, because neoliberals preach the virtues of the market but in practice are normally simply pro-business, this does not mean that you should always oppose markets: you can be pro-market and anti-neoliberal. More generally, just because neoliberals can use ideas from economics to argue their case does not mean there is something wrong with economics (as opposed to some economists). Louis Zingales, from Chicago, exemplifies both points, and is not afraid to make the distinction between pro-market and pro-business in public.

This is all related to the distinction between ideas and interests. While it is right to recognise that interests are to some extent based on ideas, it is also important to see that ideas can change in time to reflect interests. How an ideology based on seeing markets through rose colored spectacles turned into an ideology justifying crony capitalism is at least part of the story of neoliberalism. These compromises with power allowed the ideology to become dominant, but at the same time it also made it rather easy for it to be subverted by different kinds of plutocracies, such as those represented by Brexit and Trump.

Originally published at Mainly Macro here.

2018 January 27