In Search of a Paradigm Shift

The way out of the global financial crisis is through a new paradigm in economics. Only problem: no one knows what it will look like.

Today’s global economic crisis is producing a fundamental change in the relationship of government to the economy. A paradigm shift is underway, the effects of which will be felt for many years to come.

There have been two similar paradigm shifts since the end of the Second World War – both borne of crisis, and both shaped the basic governing framework in western democracies for decades. The first began in the late 1940s and lasted about a quarter century. This is what we might call the Keynes-Beveridge model, named after the great British intellectuals John Maynard Keynes and William Henry Beveridge.

After World War Two, western governments were petrified by the prospect of a return to Depression as the war economy de-mobilized. The ideas of Keynes, Beveridge and their disciples were seized upon to varying degrees to avoid a return to economic contraction, high unemployment and social unrest. The underlying assumption was that markets almost always require government intervention to function properly. Economies would be fine-tuned through fiscal and monetary policy to ensure steady economic growth and an end to recessions. This would be linked to the building of a “welfare state” – replete with innovations like unemployment and health insurance – to support growth and protect citizens from the worst effects of an unfettered market economy.

The Keynes-Beveridge model was “on the shelf” for post-war governments to pull down, its intellectual foundations having been worked out over the previous decade. And it served most countries relatively well, supporting the prosperity and social progress of the 1950s and 1960s.

By the mid 1970s, a new economic crisis – characterized by the twin evils of high unemployment and inflation – took hold. The old post-war paradigm seemed incapable of fixing this problem; some saw it as exacerbating the malaise by fuelling inflation and contributing to inefficient and sclerotic economies. A paradigm shift was in order. Then, as before, a body of intellectual work was on the shelf for governments to adopt. The new approach was what we might call the Friedman-Thatcher model, named after the great American economist Milton Friedman and former British Prime Minister Margaret Thatcher. The model called for an all-out assault on inflation through rigorous control of the money supply, plus tax cuts, fiscal discipline and a smaller, less intrusive government, underpinned by an over-riding emphasis on the free play of market forces. In contrast – or even in reaction to – its predecessor, this approach assumed markets require little, if any, government intervention to function properly.

To varying, albeit diminishing, degrees, the Friedman-Thatcher model has provided the basic governing framework for many Western governments, especially the Anglo-American democracies, for the past quarter century. It has been widely credited with contributing to the prosperity of the past two decades.

But the current economic crisis has exposed the flaws in this model. Its core notion that markets should be put on a high pedestal has been discredited.

A paradigm shift is once again called for. However, unlike earlier eras, there is no alternative intellectual model that can be pulled off the shelf and adopted by governments as a framework. The essence of the Friedman-Thatcher model was so widely accepted – even among centrist and centre-left governments like New Labour in the UK, the Chretien-Martin Liberals in Canada and the Clinton Democrats in the U.S. – that no one bothered to develop an alternative framework for governing in the event the model broke down. We had reached the end of history – the superior model had triumphed and would last forever.

Today, some have suggested that we are all Keynesians again. That is true in the short but not the long run. Keynesian fiscal stimulus is a hallmark of how governments from China to Canada, from conservative to social democrat, are trying to deal with the current recession. It is the only proven way to help jolt economies back to life and prevent a deflationary spiral. But it is hard to imagine that once growth returns, the world’s leading economies will embrace the post-war fine-tuning of economies and expansion of social programs that characterized the '50s and '60s.

A new framework for governing, post Friedman-Thatcher, is now required. But at this point no one really has a clue what it will look like. And rather than emerging from the academy as in previous eras, the alternative framework will likely get pieced together over time by governments as they try to find ways to prevent a similar economic crisis from happening again. It will be much less determined by a theory of government’s role in the economy, and much more through learning by doing, through trial and error. That might prove to be a good thing, leading to a more flexible, lasting, pragmatic and appropriate framework. After all, as Edmund Burke once said, there is nothing more dangerous than governing in the name of a theory.