Neoliberalism: the bargain Britain made - and the bill we’re still paying

There is a fairly good chance you have heard the word neoliberalism used as an insult. It normally appears in political arguments as shorthand for everything someone thinks has gone wrong with capitalism over the last forty years. That makes it sound complicated and ideological, when the basic idea is actually quite simple.

At its core, neoliberalism is the belief that markets are generally better at allocating money and resources than governments are. In practice, that means more private ownership, fewer restrictions on business, lower barriers to trade and investment, less power for organised labour and a greater expectation that individuals should provide for themselves rather than relying on the state.

The state does not disappear under neoliberalism. It changes jobs. Rather than owning the railway, the energy company or the telephone network, government increasingly regulates those industries while private businesses operate them. Rather than deciding where capital should go, it creates a framework and allows investors, companies and consumers to make those decisions.

The theory is not inherently ridiculous. In fact, a lot of it is quite persuasive. Make it easier to invest, reward people who take risks, allow bad businesses to fail, reduce bureaucracy, encourage competition and let capital flow towards productive opportunities. If that creates more businesses, more jobs and more investment, then living standards should rise.

That was the bargain. Neoliberalism was not originally sold as a plan to make a tiny number of people extraordinarily wealthy. The argument was that allowing people to become wealthy would encourage investment, entrepreneurship and innovation, and that the benefits would eventually spread through the wider economy.

For a while, parts of that argument appeared to work.

Why Britain changed direction

To understand why Britain embraced this philosophy, you have to understand the country Margaret Thatcher inherited in 1979. Post-war Britain had a much larger state-owned economy, powerful trade unions, high top rates of tax and governments that intervened heavily in industry.

By the 1970s, that model was under serious strain. Britain suffered from high inflation, weak productivity, repeated industrial disputes and a general sense that the economy was no longer functioning particularly well. The government sought assistance from the IMF in 1976, and the Winter of Discontent at the end of the decade helped reinforce the public impression that something fundamental needed to change.

Thatcher therefore did not arrive with an economic philosophy nobody had asked for. She arrived at a moment when a significant part of the country had lost confidence in the existing settlement. Her answer was a much stronger reliance on markets, private ownership and individual responsibility.

From 1979 onwards, Britain began changing the relationship between government, workers, businesses and capital. State-owned businesses were privatised, trade union power was reduced, financial markets were deregulated, exchange controls were abolished and top rates of income tax were cut. Council tenants were also given the right to buy their homes, creating a major expansion of private home ownership.

The broad message was straightforward: government should stop trying to run large parts of the economy and allow markets to do more of the work.

Some of those reforms addressed genuine problems. Some nationalised industries were inefficient. Industrial relations did need reform. Inflation needed to be controlled, and Britain needed more entrepreneurship and investment. It is difficult to have a sensible discussion about neoliberalism if we pretend none of that was true.

The short-term gains

The new model had obvious benefits. Privatisation raised money for government and transferred commercial risk into private hands. The sale of council housing created large numbers of new homeowners. Financial deregulation strengthened London's position as a global financial centre, while lower tax rates and fewer restrictions made Britain more attractive to entrepreneurs and international investors.

Consumers generally had more choice, access to credit expanded and ownership of property and financial assets became increasingly valuable. For millions of people, particularly those who bought homes or owned shares and pensions, the reforms felt like progress because they were progress.

The problem was not necessarily what neoliberalism achieved in its first decade. The problem was what happened when Britain kept applying the same philosophy long after the original problems had changed.

That is where the story becomes more interesting.

When Britain started to falter

There is no single year when Britain suddenly crossed a line and neoliberalism stopped working. A better way to understand it is as a gradual shift in the balance of the economy.

The first major warning sign appeared in the 1980s, when income inequality widened sharply. That did not automatically mean the economic model had failed. A society can become more unequal while most people are still getting better off. If the economy grows strongly and wages rise across the board, people may tolerate a widening gap between the top and the bottom.

The more important change came later, when ownership of assets became increasingly important relative to income from work. By the 2000s, Britain had become an economy where property, shares, businesses, land and pensions increasingly determined people's financial position.

If you already owned assets, rising prices worked in your favour. If you were trying to buy those assets from wages, they gradually moved further away from you.

Then came the financial crisis in 2008. Britain, like other developed economies, responded by cutting interest rates dramatically and taking extraordinary measures to stabilise the financial system. There were very good reasons for doing that because allowing major banks to collapse would have caused enormous damage.

But there was also a distributional consequence. Lower interest rates and policies designed to support financial markets helped asset prices recover. That disproportionately benefited people who already owned significant quantities of property, shares and other investments.

This is where aggregate wealth can become misleading. A country can become much wealthier on paper without the average person's economic life improving by anything like the same amount. If ten people each have £20 and one billionaire walks into the room, the average wealth of the room suddenly looks fantastic. The original ten people have not gained a penny.

When wealth starts replacing work

For most people, the traditional route to financial security is fairly dull. You get a job, build a career, earn more over time, save, buy a house, contribute to a pension and perhaps start a business. Do that for several decades and, with some luck, you end up financially comfortable.

But once asset prices rise substantially faster than wages, the maths starts to change.

Imagine one person has £50,000 invested and another has £20 million. If both earn a 5% return, the first person makes £2,500 while the second makes £1 million. The percentage return is exactly the same. The outcome is completely different.

The following year the wealthy person does not start again with £20 million. They begin with £21 million, assuming they have not spent the return. Their capital starts earning returns on previous returns. That is compounding, and compounding becomes extraordinarily powerful when the original pot is already enormous.

This matters because labour does not scale in the same way. A person can become more skilled, work longer hours or earn a higher salary, but there is still a practical limit to what one human being can produce. Capital has no comparable constraint. £20 million can be invested while its owner sleeps.

Over several decades, that creates a structural advantage for people who already own substantial quantities of capital.

What do we mean by ultra-wealthy?

For the purposes of this argument, I am using £20 million of net wealth as the point at which somebody becomes ultra-wealthy. This is not an official government definition. It is simply a useful dividing line.

There is a meaningful difference between someone who owns a valuable house and has built a good pension, and someone with £20 million of investable assets.

At the latter level, you are no longer relying primarily on your salary to create financial security. Your assets themselves can produce substantial amounts of income. You may own businesses, commercial property, investments, land or stakes in private companies. You can also access professional investment management, specialist tax advice and investment opportunities that are simply unavailable to ordinary households.

That does not make someone immoral. Wealth is not, by itself, a problem.

The issue is what happens when an increasingly large proportion of the nation's assets becomes concentrated among people whose wealth is already large enough to reproduce itself.

Why concentration matters

A perfectly reasonable response is to ask why we should care if somebody is worth £20 million, £100 million or £1 billion. If they built a successful company, employed people and created something useful, then becoming wealthy is a fairly logical outcome.

The problem is not wealth creation. The problem is concentration of ownership.

Imagine a town with 10,000 homes. If most of those homes are owned by the people who live in them, housing wealth is distributed relatively widely. Now imagine that, over time, a growing proportion of those properties is bought by wealthy landlords, investment funds and companies.

The houses have not disappeared. GDP may not change dramatically. The streets look the same.

But the flow of money has changed.

Instead of mortgage payments gradually creating equity for households, a larger proportion of wages begins flowing towards landlords and investors as rent. Those owners can then use that income to purchase more assets, which generate more income, which can be used to purchase still more assets.

That is how concentration can become self-reinforcing without anyone needing to sit in a room and design it.

Productive capitalism and rentier capitalism

This is where an important distinction needs to be made.

Capitalism at its best is extremely productive. Somebody risks their money to build a business. They create a product people want, employ workers, improve technology, compete with other businesses and hopefully become wealthy if they succeed.

There is nothing particularly troubling about that. In fact, Britain could probably do with more people building successful businesses.

Rentier capitalism is different. Instead of becoming wealthy by creating something new, wealth comes increasingly from controlling assets other people need to access. Property is the obvious example, but the same principle can apply to land, infrastructure, intellectual property and other scarce assets.

Think of it as the difference between building a bridge and owning the only bridge into town.

The first creates something useful. The second can become extremely profitable simply because everyone else has to pay to cross it.

This is where the concern around wealth concentration becomes stronger. If large fortunes are primarily being created through innovation, business formation and productivity growth, then society is getting something in return. If fortunes increasingly grow through ownership of existing scarce assets, then a larger share of the economy can start behaving like a collection of toll booths.

Then inheritance arrives

Accumulated wealth has another characteristic. Eventually it gets passed on.

This complicates the argument that large differences in wealth are simply the natural reward for talent, hard work and risk-taking. You can make a strong case that somebody who builds a £100 million company deserves to enjoy the rewards.

It is more difficult to make the same argument about somebody inheriting £20 million because their grandparents made good decisions several decades earlier.

As large fortunes compound and move between generations, inheritance becomes increasingly important in determining people's economic starting points. That changes the nature of opportunity.

Two people can have the same education, the same salary and work equally hard, but if one receives a substantial inheritance and the other does not, their financial lives quickly diverge. One can buy a house earlier, invest more, take greater risks, start a business or help their own children onto the property ladder.

The advantage then compounds again.

At some point, a supposedly meritocratic economy starts placing more weight on what your parents owned than what you personally produce. That begins to look less like capitalism rewarding enterprise and more like aristocracy with better Wi-Fi.

Inequality is not automatically the problem

It is worth being careful here because inequality itself is not necessarily evidence that an economy is failing.

If one person earns £50,000 and another earns £500,000, then both incomes double, inequality has not narrowed. But both people are materially better off.

That is why arguments focused entirely on whether billionaires exist tend to miss the point.

The more useful questions are whether ordinary living standards are rising, whether people can still acquire assets through work, whether markets remain genuinely competitive and whether somebody born without wealth has a realistic chance of building it.

Can young people afford homes without parental help? Can workers capture a reasonable share of productivity improvements? Can entrepreneurs still compete with established owners of capital? Do people believe working hard and doing the right things will materially improve their lives?

Those questions matter much more than whether somebody owns a yacht.

Where Britain may really have gone wrong

Britain's problem is therefore not simply that wealthy people became wealthier. It is that the economic ladder underneath them appears to have become harder to climb.

As asset values increased relative to wages, two people earning exactly the same salary could experience completely different financial outcomes depending on whether they already owned property or received family wealth.

One person might inherit enough for a house deposit at 27. The other spends another decade renting while trying to save one. During those ten years, the first person's mortgage payments build equity while the second person's rent builds somebody else's equity.

If house prices rise, the gap becomes larger. The first person can later borrow against that equity, invest it, start a business or help their children buy property. None of this requires anyone involved to behave badly.

That is the uncomfortable point. The system can generate greater concentration even when every individual person is behaving perfectly rationally.

The mathematics of £20 million

The effect becomes clearer when you return to the £20 million threshold.

Take somebody with £20 million invested and assume, purely as an illustration, an average annual return of 5%. Ignoring tax and spending, that capital grows to around £53 million after twenty years. At 7%, it becomes roughly £77 million.

The owner has not needed to invent another product, build another factory or work another million hours. The original capital has simply compounded.

Now repeat that process across thousands of large fortunes, and allow some of that growing capital to buy property, businesses, infrastructure and land from people with smaller balance sheets. Ownership naturally begins to concentrate.

Again, this does not require a conspiracy. It is the natural arithmetic of capital. Money scales. Human labour does not.

Why this becomes a societal problem

Once wealth concentration reaches a certain level, the consequences extend beyond the bank accounts of rich individuals.

Housing ownership becomes increasingly divided between people inside and outside the asset economy. Inheritance plays a larger role in determining people's prospects. Geographic inequality can become more entrenched, particularly when valuable property and business assets are concentrated in certain parts of the country.

Large differences in wealth also create different relationships with public services. Someone with significant capital can pay privately for education, healthcare, security and transport when public provision deteriorates. That weakens the extent to which wealthy households share the same everyday systems as everyone else.

There is also a question of political influence. Money provides access to professional lobbying, campaign funding, specialist advisers, media ownership and networks that ordinary citizens do not have. That does not mean every wealthy person is buying politicians, but it would be naïve to pretend extreme financial resources create no political advantage.

Perhaps the biggest consequence, however, is psychological.

Capitalist societies rely on people believing the system broadly works. Most people are willing to accept that some individuals will become vastly wealthier than others if they believe those rewards came from creating value and that they themselves still have a meaningful route to advancement.

What becomes dangerous is a society where increasing numbers of people conclude that work matters less than ownership and that their financial future was substantially determined before they were born. At that point, the problem is no longer simply inequality. It is legitimacy.

So did neoliberalism fail?

Not entirely. That is what makes the argument uncomfortable again.

The reforms introduced from 1979 onwards addressed genuine weaknesses in Britain's post-war economic model. Competition matters. Entrepreneurship matters. Private investment matters. Profit incentives matter. Markets are often extremely good at organising economic activity.

The mistake was turning those useful principles into something closer to a religion.

Britain gradually began treating market outcomes as though they were automatically good outcomes. House prices rise, so homeowners are wealthier. Asset prices rise, so pension funds are stronger. Foreign capital buys British infrastructure, so Britain is attracting investment. Private investors acquire essential assets, so capital must be being allocated efficiently.

Each decision can make perfect sense in isolation. Add them together over several decades and you can end up somewhere much stranger.

You can have a country that looks extremely wealthy on paper while a large part of the population struggles to acquire the basic assets previous generations accumulated much more easily.

The real argument Britain needs to have

The debate should not really be capitalism versus socialism. That argument is too crude and, frankly, about forty years out of date. The better question is what sort of capitalism Britain wants.

If someone becomes extremely wealthy by building a company, developing technology, employing thousands of people or finding a way to make the economy more productive, good. We should probably be trying to create more people like that.

If increasingly large fortunes are generated by owning existing assets, extracting income from them and passing those assets down through generations, then we should at least question whether the economic incentives are producing the society we want.

There is a significant difference between wealth creation and wealth extraction.

They can look remarkably similar on a balance sheet.

Over forty years, they create very different countries.