New Classical Theory

During the 1980s, mainstream economic theory rejected Keynesianism and returned to its Classical market roots, with its emphasis on market freedom and a limited role for the state. Both the IMF and World Bank quickly began to adopt this New-classical perspective.

Three different New-classical approaches emerged;

  1. The free-market approach, where markets alone are assumed to be sufficient to generate maximum welfare.

  2. The public-choice approach, which is an extreme New-classical model which emphasises that all government is ‘bad’ and leads to corruption and the gradual confiscation of private property.

  3. The market-friendly approach, which suggests that, while markets work, they sometimes fail to emerge, and a government has an important role in compensating for three main market failures: missing markets, imperfect knowledge and externalities.

New-classical theorists rejected the Keynesian view which dominated the 1970s. Despite differences of emphasis, they have tended to agree that development is best left to markets. In particular, New-classical economists believe that, to develop, countries must liberate their markets, encourage entrepreneurship (risk taking), privatise state owned industries, and reform labour markets, such as by reducing the powers of trade unions.

Trade liberalisation

There is a broad consensus between New-classical economists that free trade can help stimulate growth and development by encouraging inward investment and the application of economies of scale and economies of scope, increasing competition and breaking down domestic monopolies and creating a low inflation environment.