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FEATURE Choosing between Classical and Social Liberalism

Social support markets, but also to promote a firm safety net and , with more confidence in the role of government, writes Fred Argy

lassical liberals and social liberals share easy it is for entrepreneurs to start and manage some common views. Contrary to state their business); the extent of of labour paternalists, they both see benefit in markets (how much managers have in market reform, but are less radical than setting pay structures and in hiring and firing); Clibertarians. Contrary to social conservatives, they and the size of government (scale of government often agree that the state should use a light hand expenditure). Libertarians also tend to have a when regulating personal morality. Yet there is still laissez-faire attitude to the environment.1 a lively debate between classical and social liberals Some people on the political Right (and some on the scope of , the scale of measures to on ) also demonstrate elements of ‘social promote substantive equality of opportunity, and ’ in areas such as homosexuality, on the degree of economic intervention consistent drugs, obscene literature, , or federal with . funding for human embryonic stem cell research. These issues stir up deep passions when people Libertarians generally divorce themselves from with prior beliefs and values dominate the debate as they believe people should (ideologues). The discussion becomes more be able to pursue whatever ideals they like. civilised when people have regard for a realistic Some people on the Left actively support state ‘set of political values’ (academics and journalists). paternalism, a mix of democratic and And when the war of words becomes central to welfare ‘.’ The methods and instruments government, ideology loses much of its sting—at chosen include guaranteed social minima; trade least on the surface (politicians). barriers; exchange controls; a managed exchange The ideological debate At the ideological level, there is little room for Fred Argy has advised sensible argument. from Menzies to Keating. He was ‘Libertarians’ reject any sort of state intervention awarded an OBE and AM for services apart from a minimal role that protects against force, theft and fraud. Under libertarian to economic planning. He is the author , failing to help people in need does of many articles and several books, not restrict . , as measured including Australia at the Crossroads in the so-called ‘index of economic freedom,’ is (Allen & Unwin) and Equality of calculated by reference to the security of property Opportunity in Australia: Myth and rights; the openness of the economy to external Reality (The Australia Institute). trade; levels of business and credit (how

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rate; a rigid, inflexible wage structure; public classical liberal sees a need to redistribute income, ownership; and foreign investment regulation. it would be not to reduce inequality per se but Social liberals divorce themselves from these instead address specific individual needs such as policies, which seem unnecessarily costly for increasing incentives or assistance for the elderly. productivity and flexibility. There are more This explains why classical liberals are sceptical effective ways of achieving good distribution of the use of ‘composite indexes designed to effects through the social security, the system, aggregate different or inequalities’—such and moderate wage regulation. as the Gini coefficient or shares of income—and The doctrines of , social why they are more ‘flexible’ on the issue of tax conservatism, and state paternalism are held cuts relative to expenditure.3 mostly by ‘political outsiders.’2 Most academics Like libertarians, classical liberals refuse to see and political participants, while drawing heavily themselves as ‘moral conservatives’; instead, they on prior ideology, lean toward a more realistic generally oppose censorship and support improved view of politics. This is what we call ‘progressive legal recognition of gay relationships and abortion liberalism’—a pragmatic mix of markets and rights for women.4 government intervention to promote economic Classical liberals are ‘at least first cousins’ to growth while promoting equality, opportunity, libertarians, with a similar stress on the role of and a welfare safety net. Progressive liberalism is government. However, classical liberals are more the governing orthodoxy of the day. pragmatic, and their ideas are somewhat closer to political realities. The academic debate How much social liberalism? At the academic or journalistic level, there is an One aspect of ‘equity’ that is widely accepted ongoing debate between organisations such as (by both sides of the fence) is that people in the the Institute of Public Affairs, the Centre for same circumstances should be treated the same Independent Studies, and the Australia Institute (i.e. ensuring processes are transparent and non- and between bloggers and individual writers. They discriminatory on the basis of race, religion, sex, contribute to, and scan through, learned articles— or sexual preference). and use the ideas in them to pursue particular But social liberals (the principal topic of this political ends. Two of the main exponents are paper) go further with their ideals of equity. They classical liberals and social liberals. believe in a strong safety net, and they support How much economic freedom? substantive equality of opportunity. These two Classical liberals can be viewed as ‘less extreme’ equity wings of social liberalism interact with a than libertarians. For example, they adopt a third—a strong belief in economic liberalism. more intellectually eclectic set of justifications instead of a simple assertion of rights. While Strong safety net favouring libertarian institutions, such as limited Classical liberals and social liberals have much in government, protection of personal , and common regarding the existing distribution of free markets, they rely on rules of thumb derived income, although they are likely to differ regarding from experience—for example, that governments individual needs and degree of opposition to tend to mess things up and individuals are the further redistribution of incomes. best judges of their own interests. They see the The social liberal insistence on a firm safety net libertarian label as too narrow and as representing can cause some differences with classical liberals, a too absolutist view of politics and policy. but three considerations pull them . Classical liberals like Policy editor Andrew First, income distribution in Australia happens Norton see ‘an inherent, massive complexity’ in to fall mid-way in OECD circles, and appears income inequality, which is the result of ‘billions to be roughly consistent with public opinion. of individual decisions, actions and transactions Second, many social liberals share the classical taken over a long period of time’ and reflecting liberal view that governments need to identify a different talents, abilities, effort, and luck. When a specific individual instance of ‘inequity’ before

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intervening to alter income distribution. They be offered a special system of wage insurance. If differ from social , who tend to be such ideas fail (e.g. it might be hard to precisely guided by particular points in income distribution. identify the victims), government could invest in Third, social liberals also fear that the economic socially active yet productive programs. efficiency costs of a marked shift in distribution It is worth noting that this kind of social can often exceed the welfare benefits. In particular, liberalism, like libertarianism, is committed to those able and willing to work should have every individualism—but includes protecting individuals incentive to gain employment or train. from acts of omission as well as commission. However, differences emerge on proposed Substantive equality of opportunity policy changes likely to affect income distribution. Social liberals also attach much importance One route—the one chosen by classical liberals— to the achievement of substantive equality of is to simply look at the effects of new economic opportunity—the opportunity available to well- reform on GDP. If these effects are positive, it motivated, capable, and hard-working people is assumed that winners will potentially be able to get ahead in life and achieve their maximum to compensate losers and still remain better off. potential, no matter what their social background There is no need for actual compensation. and starting opportunities. Equality of opportunity But social liberals start with the presumption is not simply about money. Governments also have that an extra dollar (the incremental benefit of an obligation to ensure that sufficient assistance is policy-induced reform) is worth more to a poor available to directly address capability deprivation, person than a rich person, so the distribution e.g. in health, , training, housing, and effects of economic reform need to be considered transport . in order to assess its aggregate welfare benefits. If We know that social mobility (the frequency the benefits are substantial and virtually all go to with which people can move up the ladder in the rich, governments need to sympathetically the course of their lives) is highly sensitive to consider alternative policy packages that deliver a the scale and mix of policy instruments used by more neutral outcome—one more consistent with governments. Countries enjoying relatively high Pareto optimisation, where no one can be made better off without someone being made worse levels of mobility tend to have governments that off.5 Other privately initiated reforms in product encourage free, competitive markets and regulate markets also have ‘losers’—but the losers are not labour markets relatively lightly but also engage policy-initiated. in active societal redistribution. The first two market-oriented policies alone will not deliver optimal equality of opportunity. They need to Social liberalism … is committed to be supplemented by the third—redistribution to 7 individualism—but includes protecting build capabilities. individuals from acts of omission Compatibility with economic liberalism as well as commission. How does all this link up with economic liberalism—the view that decisions on what is produced and how it is to be produced are A further economic justification for such generally best left to the market, unless there is redistribution is that it can smooth the path of clear evidence of market failure and governments economic reform. If people are unhappy about are able to correct the problem with a reasonable how the previous benefits of reform have been level of effectiveness. distributed, they are less likely to support policy- First, from a welfare point of view, social induced structural change.6 liberalism is more likely to ensure an economic This leads social liberals to propose various efficient (Pareto-optimal) outcome in response to policy initiatives. When a new tax, like the GST, is major reform initiatives. Second, it also facilitates contemplated, it should be to offer direct structural change. Third, market income compensation to families. And workers forced inequalities are only morally defensible and by a policy change into lower-paid jobs could economically desirable if they reflect differences in

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talent, risk-taking, and hard work. Studies suggest Privatisation that genes, pre-birth environment, and post-birth Because of some ambiguities in the meaning of influences all play a substantial role in determining ‘market failure,’ an element of ideology may have inter-generational transmission of socio-economic entered the debate. status,8 and tend to distort the present distribution Thus, classical liberals insist that private of market incomes. To ‘level the playing field,’ the ownership will generally create incentives for observed market inequality must be made fairer, efficiency—except where there are natural more economically rational, and more politically monopolies (where regulation is required) or legitimate. A number of credible studies have where commercial incentives would not be enough found evidence of high national economic returns to meet social goals, such as service provision in (in terms of real incomes per head) relative to low population areas. government outlays.9 Social liberals have a rather broader definition of But all that is not enough to convince classical market failure. As understood by most economists, liberals, who argue that government subsidies it refers to a situation in which a market left on its should be relatively small, and that government own fails to allocate resources efficiently. It allows cannot do things as well as the private sector.10 for externalities, market power, and information Social liberals need to address these issues asymmetries. It also assigns to government an by focusing specifically on four key policy important role in the delivery of the services, such differences—size of government; privatisation of as in the case of Telstra.13 state enterprises; financial regulation and labour Assigning infrastructure ownership risks market deregulation. predominantly to the private sector can also lead to a misallocation of capital resources. For Small government example, it tends to encourage infrastructure There is no such thing as an ‘optimal’ size of with good ‘commercial potential’ and discourage government from an economic point of view: infrastructure with high ‘social returns.’ Classical It is hard to find a statistical correlation between liberals also allow for such situations, but on a size of government (levels of government spending smaller scale than social liberals. and taxation) and economic performance.11 Tax increases can have significant incentive 12 Financial regulation costs (although there is controversy even here ), The global financial crisis, its causes, and remedies with the so-called ‘deadweight’ (choice distorting, have an ideological dimension that touches on the welfare-reducing) costs of higher possibly as differences between and classical liberals. high as 20 cents in the dollar. But the net economic costs of tax increases depend on: • Some people look for ‘external’ factors; for example, blaming it all on the US Federal • the initial tax levels (efficiency costs increase Reserve’s monetary policy, untruthful approximately with the square of the tax homeowners, and the role of global rate); imbalances, such as the huge current account • how the revenue is raised (how much it surpluses run by countries like China influences work incentives and capital (libertarians and, to a more moderate extent, movements and how much it distorts classical liberals) choice); • Some people want somewhat tighter • how productively the money is spent regulation, such as higher capital ratios for (spending needs to be assessed, program by banks and a wider prosecution of fraud, but program, to see whether it is justified). with ‘warnings against micromanagement’ Spending programs need to be evaluated (Greenspan) without any presumption in favour or against. In • Some go further. They argue that bad particular, if the economy is facing the prospect incentives (such as those of commission- of a severe recession, the case for contra-cyclical based mortgage brokers and the biased role spending is very strong. of rating agencies) are partly to blame. And

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they also view regulation as a failure by international pressures, trade unions have a role permitting very close ‘pathways’ between to play in protecting low-paid employment. the banking and non-traditional banking There is also the wider issue of perceived sector. They want the regulatory authorities ‘fairness’—getting a fair share of the benefits of to either ensure that traditional banks do without having to depend on a not take on excessive risks through their social security system that is already under threat relationship with lightly regulated entities— as it gets larger. leaving it to the markets to investigate and This would require that more workers have to monitor the hedge funds or investment be retrained or are made more job-ready for other companies or their use of derivatives; or activities. Ultimately a value judgment is needed. else the same regulatory framework could The political debate apply to the shadow banking sector as to the banking sector (Ben Bernanke and, in a Academic and journalistic contributions soften more extreme form, ). the role of self-interest, but they still retain many of the vestiges of ideology. The third group— lean more strongly to the third politicians—are normally the least ideological of the three. Their own interest lies in accurately Social liberals … want to see the reading the electorate’s beliefs and stated views. Prior ideology continues to influence ideas but its system of regulation address role is more camouflaged. Former Prime Minister the problems of panics, John Howard often pointed to ‘the hard edges crashes and bubbles. of the American approach,’ and argued that the is ‘not a party of the hard right—it is a party of the centre right, a party which rejects option. In particular, they want to see the system extremes.’15 of regulation address the problems of panics, But he still managed to cautiously push crashes and bubbles—which occur because his own agenda. He neglected lower-income of irrationality, asymmetries of information families without kids, and used tax policy to (imperfect knowledge), and market psychology. disproportionately benefit the rich (such as halving capital gains tax, abandoning measures to reduce Labour market freedom tax avoidance through trusts and companies, The gap between libertarians and classical liberals and weighing superannuation towards the better is starkly evident in the debate over labour market off—all of which affected wealth distribution freedom. rather than income distribution). On the danger Classical liberals dislike unions and advocate of ‘welfare dependence,’ Howard tended to go labour market deregulation because it widens further than the ALP was prepared to live with. individual choices. On the other hand, social He took a firm stance on issues such as waterfront liberals support deregulation of the labour market reform, the GST (prior to its resolution in the only where it is expected to produce significant Parliament), and the privatisation of Telstra. The social or economic benefits.14 government’s final assault was on labour market They know that freeing up the constraints on deregulation. Here, he went too far and may have labour markets makes sense when the economy brought about the Liberal government’s demise. suffers from high unemployment benefits (relative But in general the attack was fairly effective. to median earnings); extensive state involvement On the other side of the fence, we find Kevin in wage determination; stringent employment Rudd warning about executive greed, distributive protection; and exposure to militant trade inequity, the need for opportunity-levelling new unions. But this can easily go too far. Some back- investment, the potential valuable role of unions in pedalling is needed to ensure that labour has a the new IR system, the limits of privatisation, and reasonable balance of power. For example, while the role of big government in times of global crisis. labour markets clearly need to be sensitive to More recently, in the February edition of the

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Monthly, Rudd discussed the excesses of . pensioners, carers and welfare recipients versus While his rhetoric may at times seem excessive, lower taxes) but also because Turnbull’s contra- Rudd is a long way from being a socialist or cyclical debt aversion thesis does not have the anti-liberal. backing of the Reserve Bank, Treasury, the IMF, For example, Rudd is still a free trader (leaving the OECD, and 90% of economists (according aside his support for motor vehicle protection);16 to Greg Mankiw18). Without any government his position on foreign investment is mostly liberal; intervention, the economy would be much weaker he seems willing to commit the government to and public debt could be even larger than it is. The zero net borrowing over the economic cycle— ‘permanent income hypothesis’ is only relevant as a which implies starting with a presumption in long-run supply-side response: It does not apply to favour of private sector infrastructure investment short term periods of ‘liquidity constraint.’19 over the long term; he wants to expose Australia Nonetheless, if Turnbull persists with his to competitive forces in education (e.g. making classical liberal stance, the next election will test the education conditional on school-level reporting public reaction to Labor’s big Keynesian ideas. and rewarding excellence in teaching); he is Conclusions mostly hated by militant trade unions; he is very sympathetic to moderate Aboriginal intervention Classical and social liberals have much in (e.g. adopting and preserving most of the Howard common—they share a common stance on issues government’s 99-year lease scheme); he insists on such as , limited welfare for people able future reductions in public sector size; and (until to work, and the need to balance the budget over now) he has refused to consider a rise in New Start the economic cycle. (unemployment) benefits. But they are often at variance on the degree With electoral opinion centred in the middle, of government involvement—such as on social the public debate on politics continues around the welfare, the promotion of equality of opportunity, edges. Based on my understanding of opinion polls, and government intervention in the economy. a high proportion of Australians seem to believe The extent of these differences is most acute at that we already have equality of opportunity; for the firmly ideological level but becomes more example, there is a fairly widespread view that able- moderate as people start to have regard for political bodied working age Australians who are in sensibilities. ‘are to blame for their situation to some degree,’ In the recent survey by Andrew Norton of while only 15–20% disagree with the proposition Australian political identity, I described myself 20 that ‘people are rewarded for their skills and effort.’17 as someone with social liberal views. This has Yet there is strong sense of ‘what is fair’: People several features: feel uneasy about the treatment of pensioners and • It has a broader safety net—one that broadly the inequality of access to public services. Only a accepts the existing distribution of incomes, minority want governments to embrace labour apart from addressing specific individual market deregulation (as we saw in the reactions to needs that seem anomalous, but which allows WorkChoices). governments to manage the distribution Malcolm Turnbull’s economic agenda may effects of new economic reform; have recently moved to the right. For example, • It includes a commitment to substantive we note his strong stance on ‘small’ versus ‘big’ equality of opportunity; and government, and his advocacy of ‘general tax cuts’ • It has a greater (ideological) faith in in preference to the government’s policy of upfront government’s ability to effectively address cash grants. Turnbull is asking ‘why do we assume market failure; this contrasts with the the government will invest that money more wisely classical liberal view (again ideological) that than the people who earned it’? governments tend to mess things up, fail His new stance on ‘small government’ could to independently assess and address market prove a difficult act to apply in practice—not just failure, and individuals are the best judges of because of conflicting goals (more spending on their own interests.

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My social liberal leanings lead me into a Journal of Economic Analysis and Policy 7:2 (2007), and more neutral policy position. For example, ‘Social mobility and statistical immobility,’ Andrew I prefer government spending programs and Leigh’s blog, 9 April 2009, http://andrewleigh. privatisation of government assets to be judged com/?p=2028. 8 Sources include James R Flynn, What is Intelligence: on their merit—without any presumption for or Beyond the Flynn Effect (Cambridge: Cambridge against. It also leans me towards greater financial University Press, 2007); and ‘Nature v/s nurture, regulation. And, while favouring a relatively free poverty matters,’ Economist 23 July 2006. labour market, I would inject enough restrictions 9 The national returns come in the form of a better on the free play of demand and supply (e.g. on educated and skilled workforce and citizenry; greater minimum wages and unfair dismissals) to ensure geographic and occupational mobility of labour; a level playing field and ‘fairness’ goals. less waste of potentially successful entrepreneurs; higher employment participation rates; diminished health costs; lower imprisonment rates; less spending Endnotes on welfare and juvenile delinquency; savings in 1 Harry Clarke is an exception: He is an inveterate commuting time; and fewer accidents and reduced supporter of labour market deregulation and small pollution. government—yet he is a source of support for the 10 Andrew Norton, ‘Slipping social mobility,’ Catallaxy environment and distribution. blog, 18 April 2006, www.catallaxyfiles.com/blog/ 2 Harry Clarke, ‘The end of fundamentalism, ?p=1707. not of the ,’ On Line Opinion, 5 11 Fred Argy, ‘Australia’s fiscal straightjacket,’ John December 2008. Butcher (ed.) Australia Under Construction (ANU, 3 Andrew Norton puts his point of view as follows: ‘I say 2006), 71–82. there should be less tax’ but ‘I never say exactly how Fred Argy, ‘ for the future,’ State of the States, much tax I think should be levied, or what tax rates I Evatt Foundation, 2006, 62–73. would be happy with’ (‘The intellectual uses of liberty 12 Michael Keating, in his recent book Who Rules and equality,’ Andrew Norton’s blog, 6 April 2008, (Federation Press, 2004), points to literature that finds http://andrewnorton.info/2008/04/the-intellectual- that ‘there is not much of taxation uses-of-liberty-and-equality/.) affecting the supply of labour or saving,’ 29. 4 See Andrew Norton’s analysis of the Survey of 13 John Quiggin, ‘The Australian case for nationalisation,’ Australian Political Identity on his blog, ‘Are classical blog, 25 January 2009, http://johnquiggin.com/ liberals and libertarians the same?’ 12 April 2009, index.php/archives/2009/01/25/the-australian-case- http://andrewnorton.info/2009/04/are-classical- for-nationalisation/. 14 See further discussion in Fred Argy, ‘Economic liberals-and-conservatives-the-same/. freedom: The good, the bad and the ugly,’ AQ:Journal 5 As one of the fathers of welfare economics of Contemporary Analysis (September–October 2007), (Ian Little) put it, ‘scarcely anyone would want to 36–38. say that all changes such that the gainers could over- 15 John Howard, ‘Turnbull is on track,’ The Australian, compensate the losers must be good. For most people 20 February 2009. it would depend on who the uncompensated losers 16 Kevin Rudd said on 31 January 2009 at a press were,’ IMD Little, A Critique of Welfare Economics conference (which hit the newsstands a few days (OUP: London, 1950), 93. See also Fred Argy, before The Monthly) that ‘The Australian Government ‘Distribution effects of labour deregulation,’ Agenda position has never changed. It is a position informed 14:2 (2007). by history and the appalling history of the Smooth- 6 The risks of protectionism are markedly lessened when Hawley tariff of the 1930s’ and stressing the ‘need not governments try hard to ‘share the pains and gains’ of to throw the baby out of with the bathwater.’ such reform. See AM Mayda and KH O’Rourke, ‘Big 17 Fred Argy, ‘Equality of opportunity in Australia: Myth governments and globalisation are complementary,’ and reality,’ as above, 51–56. VO.EU, 12 November 2007, www.voxeu.org/index. 18 Greg Mankiw’s blog, ‘News flash: Economists agree,’ php?q=node/705. 14 February 2009, http://gregmankiw.blogspot. 7 Fred Argy, ‘Equality of opportunity in Australia: Myth com/2009/02/news-flash-economists-agree.html. and reality,’ Australia Institute Discussion Paper No. 19 Fred Argy, ‘Fiscal policy: The ideological war,’ On 85, April 2006. See Andrew Leigh’s revised paper on Line Opinion, 4 March 2009, www.onlineopinion. ‘international elasticity of earnings,’ which suggested com.au/view.asp?article=8568. that Australia had a lower mobility than Scandinavia, 20 Results available at http://andrewnorton.info/ ‘Intergenerational mobility in Australia,’ The B.E. category/political-identity-survey/.

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