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ISR Issue 54, July–August 2007



REVIEWS

Cracking the Washington Consensus

Michael Perelman
Railroading Economics: The Creation of the Free Market Mythology
Monthly Review Press, 2006
238 pages $20

Review by PETRINO DiLEO

PITCHED AS a book describing how mainstream economists built the mythology of the miracle of free market economics, Michael Perelman’s Railroading Economics in the end lays out a case that because the free market inevitably leads to crisis, alternatives to laissez-faire ideology will emerge from both radical and conventional circles.

The book begins with a brief history of capitalist economics and how the discipline—which developed as purely an ideological field—became a pseudoscience. At first the role of capitalist economics was to argue for a new economic system in place of feudalism. But after the victory of capitalism was secure, the role of economists became one of obfuscation, largely aimed at defending capitalism and imbuing it with qualities of permanence in order to fend off analyses that capitalism is contradictory and transitory.

The true nature of capitalism—its tendency toward crisis and instability—has led to cracks along the way. Time and again, crises, such as the Great Depression, have pushed mainstream economists to recognize the inherent instability of market economics. There have been attempts to solve crises from above. Perelman points to schools of “war socialism” during the First World War, welfare capitalism during the 1920s and 1930s, and to a proliferation of Keynesian intervention in the economy after the Great Depression—all as examples of breaks with unfettered capitalism. For that reason alone, the book serves as a valuable chronicle of the history of modern economic thought, showing how and when ideas and policy shifted.
Perelman also correctly points to the crisis of profitability in the mid-1970s as the point of return to laissez-faire policies. But it is strange that despite spending pages earlier offering mini-profiles of major American economists and their roles in shifting ideology, Perelman makes very little mention of Milton Friedman or the Chicago School, nor does he use the term neoliberalism to describe the period.

Perelman’s intent seems to be to make the case that today’s Washington Consensus and the dominance of neoliberal thought will pass as the system enters crisis again, making space for both radical and mainstream economists to articulate alternatives. That idea rings true. Already there are some bourgeois and mainstream economists and capitalists who have begun arguing the dangers of pure laissez-faire capitalism, including George Soros, Joseph Stiglitz, Jeffrey Sachs, and even James Wolfensohn. On the left end of the spectrum, Hugo Chávez’s program in Venezuela—targeted nationalizations, paying off all debts, and resigning from the International Monetary Fund and World Bank—is a reflection of a movement to break away from neoliberalism throughout Latin America, fueled by deep popular resentment at the growth of inequality.

Perelman’s starting point is that capitalism can never escape its boom-slump cycle. Crises continue no matter what measures are put in place at the top. Laissez-faire policies may exacerbate instability as short-term gains are prioritized over long-term business plans, and where government oversight aimed at preventing excesses is relaxed or eliminated entirely. This tendency is exaggerated in the current climate where finance capital has come to dominate the system, and many profits seem to appear as a result of financial engineering rather than from profitability of a core business. Perelman uses the example of car companies today, where profits more and more come from extending credit and collecting interest from car buyers rather than from its proceeds selling cars.

He sees the postwar boom as being fueled by the emergence of the U.S. from the Second World War as the dominant world economy, and the boom was sustained through heavy investment in the arms industry. In Perelman’s view, this prosperity led to complacency. While Germany and Japan rebuilt industry with new and more efficient technologies, U.S. firms were content to sit back and reap profits with existing machinery. The 1970s was a tipping point where this model led to U.S. firms losing out and being forced into bankruptcy. That opened a new period where finance capital reemerged as a dominant force, leading to a whole new way of valuing and running businesses. Meanwhile, U.S. manufacturing industries restructured to compete globally through investment in new technology and by cutting back the industrial workforce.

The problem for Perelman comes when he offers his explanation for how crisis develops under capitalism. Like Robert Brenner, author of The Economics of Global Turbulence, Perelman hangs the central contradiction within capitalism on the question of “long-lived fixed capital”—that is, materials or machinery.

Under a theory known as “perfect competition,” capitalists invest in capital and in marginal costs (including labor) in search of profits. But if the investment proves unprofitable, capitalists will then reconfigure plants and shift production to other industries where they can meet their desired profit margins. But the theory of perfect competition breaks down extremely quickly in real-world conditions.

In particular, capitalists with enormous financial reserves or large enterprises do not move so quickly to cease working in unprofitable industries, as they hope to outlast competition and return to profitability. More important to Perelman is the idea that in some industries, it is practically impossible to rejigger production. That’s where the question of railroads enter the picture—an industry where this contradiction is most stark. A railroad can only ever be a railroad. Moreover, getting into the railroad business in the 1920s and ‘30s required enormous up-front capital—up to 70 percent. It is also difficult to block competition. Another firm could lay parallel track close to yours. And this in practice is exactly what happened.

Financial backers believed that railroads had enormous long-term profit potential, and there was a race to lay track and establish lines throughout the country. The description brings to mind the similar race between telecommunications firms to build “bandwidth” in the late 1980s.

As railroads raced to compete, freight rates fell dramatically. Because the up-front investment in rail lines and trains was treated as a “sunk cost,” there was a tendency for freight rates to fall down to marginal costs—i.e., the cost of maintenance and labor. Rail lines operated with zero profit margin, or lost money when some made the decision to charge rates below marginal costs in hopes of putting competitors out of business and winning more freight contracts. On such a basis, the original investment in fixed capital can never be recovered. This pattern played itself out over and over, as several waves of massive speculation in railroad firms were broken by waves of bankruptcies.

Perelman uses this example to illustrate why he sees the inherent contradiction of capital as being the question of fixed costs. It’s most apparent in industries with high levels of fixed capital, but it is something that he argues ends up causing a crisis of profitability for the system as a whole. It seems that Perelman is putting forward the argument as an alternative to Karl Marx’s explanation that the crises of capitalism stem from a long-term tendency of the rate of profit to fall—a view that Perelman does not mention at all.

Perelman’s implicit argument seems to be that the recent era of uniformity in thought among mainstream economists—what is largely termed as the neoliberal or Washington Consensus—will break once a major event shakes the economy. He believes that a shake-up is coming in short order because of finance capital’s destabilizing influence. And he is right that there will be elite alternatives to neoliberalism, but we can already see that they will arise under the pressure of left alternatives, already in motion. Neoliberal ideas won’t fall from grace simply because they’re nonsense—that, by itself, has never deterred a pseudo-scientist. They’ll change when the pseudo-scientists realize that they’re losing credibility in some places where it matters.

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