Peter Lyons: Mantra of free market ideology wearing thin

A well-funded public sector will help provide equal opportunity. Photo / Daily Post

Secondary teachers and radiographers have been striking. Young doctors are threatening to take similar action. There is growing frustration among public sector employees at the Government's refusal to acknowledge the validity of their pay claims.

The Government is citing the need for fiscal restraint because of the lengthy downturn being experienced here and overseas. Similar tensions are mounting in other Western economies.

This worldwide recession can be attributed to the actions of the private sector, in particular, the finance industry.

Government employees are being asked to share the pain in terms of reduced real wages. This may be necessary but it does not make it easier to stomach. This recession is the direct result of shoddy lending practices by banks and other lenders over the past decade.

Dodgy lending and the use of financial instruments of mass destruction such as mortgage securities were legalised by governments under the guise that "markets know best".

The core belief was, and still appears to be, private sector is good, government is bad.

In the United States this deregulation of the financial sector during the 1990s involved the repeal of laws such as the Glass Seagal Act introduced during the Great Depression.

This law prevented banks indulging in practices such as the securisation of mortgages. The repeal of this law contributed to the subprime disaster that sparked this recession.

In New Zealand, financial deregulation led to the removal of direct controls on bank lending. The lending binge in the past decade created rampant housing inflation and the huge build-up in private debt.

Ideas matter. In the past 25 years New Zealand has embraced the free market ideology of neoclassical economics.

This ideology states free markets, competition and the profit motive ensure a society uses its resources in the most efficient way to maximise the well-being of its citizens. I teach this mantra on a daily basis and have written text books on it. My job sometimes feels uneasily like a form of indoctrination.

From 1984, New Zealand was a laboratory for free market economics. This experiment has been described as a country that prided itself on its pragmatism encountering its first full blown ideology.

A better description would be a mugging. Yet there is still little understanding of this ideology and how it continues to shape our society. Neoclassical economics is an elegant and logically consistent theory. The only problem is it is based on some major assumptions that in the context of a society such as New Zealand simply do not work.

A key assumption is that markets are competitive with many sellers. This ensures efficiency of production and fairness of prices for consumers.

A quick glance at New Zealand's oil industry, domestic airlines, banking, electricity and telecommunications sectors suggests a distinct limitation on consumer choice among sellers.

A further assumption is consumers have perfect information about prices and products. Tell this to the thousands of investors in finance companies and property outfits who had no idea where their money was going. The owners of leaky homes would also dispute that they had full information about what they were buying.

Another assumption is resources are perfectly mobile between areas of production. This means people in Tokoroa or Thames or Dunedin can easily shift towns when a major local employer closes down. Putting their children in new schools and selling their house is regarded as a seamless, costless process. They can easily shift between locations and jobs.

According to neoclassical theory consumers are entirely rational in their decision-making. They are unaffected by the decisions of others. There is no such thing as herd behaviour. Margaret Thatcher famously stated, "There is no such thing as society."

Crowd manias that lead to share market and housing bubbles simply do not happen. Markets are always efficient. The credit crunch and near-collapse of the world financial markets simply could not happen. People are too rational for this to occur.

This is not a rant for better pay for public servants. It is a plea for New Zealanders to recognise we do have control over how we shape our society. Markets, competition and profit motives are powerful tools in ensuring economic well-being but they also have major limitations. The beliefs of neoclassical economics have become embedded in our thinking and yet many of its assumptions are severely flawed.

Our society has become very unequal in the spread of wealth, income and, worst of all, opportunity. History shows wealth tends to concentrate because talent and opportunity are never spread evenly. Pure free market policies tend to magnify this inequality. In a nation of four million people living on a small group of isolated islands, large inequalities can create all sorts of social friction.

A well-funded public sector is essential to providing equality of opportunity, particularly in health and education. Sadly we seem to be moving in the opposite direction. Let's ditch the ideology and look for pragmatic solutions.

* Peter Lyons teaches economics at St Peter's College in Epsom and has authored several economics texts.