Neoliberalism and the Paradox of a Smaller State

Neoliberalism is commonly understood as a political and economic approach that prioritises individual liberty, private property, free markets, and international trade. Its central premise is that human well-being is best advanced when individuals are free to apply their skills, make economic decisions, and pursue entrepreneurial opportunities. From this perspective, economic activity should not be directed solely by the state but shaped largely by market forces and private initiative. Nevertheless, neoliberalism does not suggest that the state has no meaningful role. Markets depend on legal frameworks and public institutions to operate effectively. The state therefore remains responsible for protecting property rights, enforcing laws and contracts, and maintaining the institutional conditions required for economic activity. This reveals a fundamental tension within neoliberal thought: when the state reduces its direct involvement in the economy to promote market freedom, does it genuinely become smaller, or does the nature of its role merely change? This question lies at the heart of the discussion that follows.

What Does a "Smaller State" Acually Means?

In neoliberal thought, a “smaller state” does not mean the complete disappearance of government or the abandonment of its basic functions. Rather, it refers to a reduced direct role for the state in economic and social life. Instead of owning, managing, or closely regulating many parts of the economy, the state is expected to make greater room for private enterprise, individual choice, and market competition. Privatization is one of the clearest expressions of this approach, as activities once carried out by the state are transferred to the private sector. Closely linked to this is deregulation, which reduces government control and allows market forces to play a larger role in shaping economic decisions. In this framework, competition is assumed to perform functions that were previously handled through direct state intervention.

The idea of a smaller state also affects social welfare. Greater responsibility is placed on individuals for their own economic security and well-being, including in areas such as education, health care, pensions, and social security. In such cases, responsibility is shifted away from the state and toward individuals or private arrangements, making personal success or failure appear more significant than collective responsibility. At the same time, the state is expected to remove barriers that limit the movement of capital and economic activity, thereby allowing markets to operate more freely across national and regional boundaries. A smaller state, then, is not an absent state, but one with a limited direct role, especially in areas that neoliberalism believes can be more effectively managed by markets and private actors.

Why Markets Still Need the State

When people talk about a free market, they sometimes make it sound as though the state has no part to play. But a market cannot function in a legal vacuum. Even when governments stop running industries or reduce their direct involvement in the economy, they still provide the basic framework that makes market activity possible. Take private property as an example. Saying that someone owns a house, a business, or a piece of land means very little unless the law recognizes and protects that ownership. Contracts work in much the same way. Two people may agree to exchange goods, provide a service, or repay a loan, but what happens if one side breaks the agreement? There needs to be a legal system capable of settling the dispute and enforcing the contract. Without that support, doing business would involve far more uncertainty and risk.

Markets also need rules, and those rules do not simply appear by themselves. Sometimes the state has to define what can be owned, how it can be exchanged, and what counts as fair competition. Pollution-trading schemes are a good example. A market for pollution rights cannot exist until a public authority decides what those rights are, sets limits, and creates a system for trading them. The state may not control every transaction, but it builds the structure within which those transactions take place. Competition creates another difficulty. We often assume that competition will automatically produce better services and lower prices. That may happen, but it is not guaranteed. Successful firms can become powerful enough to force smaller competitors out of the market. Over time, a competitive industry can end up being controlled by a monopoly or by a small group of large companies.

Some services are especially difficult to organize through ordinary competition. It would be wasteful and impractical to build several separate electricity grids, water systems, gas pipelines, sewage networks, or railway lines in the same place simply so that different companies could compete. These systems usually depend on shared infrastructure. Someone therefore has to decide who may use it, what they can charge, and what standard of service they must provide. In situations like these, state regulation is often necessary. Markets can also ignore costs that fall on people who are not directly involved in a transaction. Pollution is an obvious case. A factory may earn money from producing goods while nearby residents or the wider public deal with dirty air, contaminated water, or environmental damage. Since these costs may not be included in the product’s price, the market sends a misleading signal about the true cost of production. Governments may respond through pollution taxes, financial incentives, regulations, or tradable pollution permits. Interestingly, even approaches that strongly support free markets often accept intervention when these wider costs cannot be ignored.

Another concern is that people do not enter the market with equal information or bargaining power. A large company usually has more money, specialist knowledge, and influence than an individual consumer or a small business. These advantages can grow over time, allowing powerful participants to strengthen their position even further. Patents show how complicated this can become. They can reward invention, but they can also give patent holders the power to charge very high prices or restrict access to useful technology. For me, this is the key point: freer markets do not necessarily require the state to disappear. Instead, the state’s role changes. It may stop owning companies or managing production directly, but it continues to protect property, enforce contracts, regulate shared infrastructure, limit monopoly power, and respond to environmental and social costs. So the real question is not simply whether the state becomes bigger or smaller. The more important question is what the state is still expected to do after stepping back from direct control of the economy. That is where the deeper paradox of the neoliberal state begins.

The Paradox of the Neoliberal State

This is where the real paradox of the neoliberal state begins. Neoliberalism emphasizes individual freedom, free markets, and a limited role for government. People are meant to be free to make their own choices. But that freedom has limits. Individuals may choose for themselves, yet when they try to build strong collective institutions such as trade unions or political organizations that challenge the market system, the response changes. In this way, neoliberalism celebrates individual freedom while remaining suspicious of certain forms of collective action.

The same contradiction appears in the way democratic government is treated. According to Harvey, neoliberals were concerned about movements associated with fascism, communism, socialism, authoritarian populism, and even majority rule. As a result, they placed strong limits on democratic decision-making and relied on institutions such as the Federal Reserve and the IMF to make key decisions. These institutions are not directly shaped by ordinary democratic processes in the same way as elected governments. This creates an important contradiction: the state is supposed to interfere less, yet it still depends on powerful institutions and experts to manage and protect the system. The contradiction becomes even clearer when people organize against the neoliberal system. If social movements demand collective action or challenge the market order, the state cannot simply remain passive. It may have to intervene to protect the existing system. international competition and globalization can be used to pressure movements that oppose the neoliberal agenda. If that does not work, the state may turn to persuasion, propaganda, and, when necessary, police power or force. At this point, the state is no longer simply stepping aside. It is actively using its power to defend the system.

There is also a gap between what neoliberalism promises in theory and what governments actually do. A government may support free markets and free trade, yet still intervene when it sees fit. Example of President Bush, who supported free trade but imposed steel tariffs. He also points to European governments protecting agriculture while supporting free trade in other areas. States can also intervene in ways that benefit particular business interests. These examples show that governments do not always follow neoliberal principles in a completely consistent way. This is the central paradox of the neoliberal state. The state may reduce its direct role in running businesses or managing the economy, but that does not mean it disappears or becomes powerless. It can still use its political, legal, and institutional power to protect the market system. In other words, the neoliberal state may become smaller in some areas while remaining very powerful in others. The promise of less state intervention therefore does not necessarily lead to less state power; instead, it often changes where and how that power is used.

Smaller Does Not Always Mean Weaker

When people talk about a “smaller state” under neoliberalism, it is easy to assume the state is simply losing power. But that is not always true. The state may reduce its direct control over businesses, industries, and public services, while still playing a major role in shaping how markets work. In this sense, the state can become smaller as an owner without becoming smaller as an authority. Neoliberalism tends to support privatization and deregulation. Areas once run or closely controlled by the state are moved into the private sector. Even so, the state still has important work to do. It must protect private property, enforce contracts, and set the rules for competition. In some cases, when market rules are unclear or property rights are hard to define, the state still has to step in and create those rules.

There are also some areas where the market cannot simply be left alone. Electricity grids, gas pipelines, water systems, and railways are examples where many competing systems would not make practical sense. In these cases, some form of state regulation is hard to avoid. The same issue appears when markets fail, such as when firms pass the cost of pollution on to society. Even neoliberals have to deal with these problems, either through limited intervention or through market-based regulation. The issue becomes even more important when competition does not create a level playing field. People and firms do not always have the same information or the same power. Stronger players can use their advantages to gain even more control, and patents can sometimes give their owners monopoly power. In such cases, the state may need to step in to address these inequalities.

This gives us a different way to understand the idea of a smaller state. The state is not necessarily disappearing; its role is changing. Instead of directly running an industry, it may set rules, oversee the market, protect property rights, and intervene when the system stops working properly. Some scholars describe this broader shift as the rise of the “regulatory state” or “regulatory capitalism,” where regulation, monitoring, and enforcement become more important parts of government. So, the better question is not whether neoliberalism makes the state weak. The more useful question is what the state stops doing and what it still controls. A government can give up ownership of an industry and still shape it through laws, regulations, and institutions. The state may look smaller from the outside, while its power remains in a different form.

The idea of a “smaller state” under neoliberalism is more complicated than simply reducing government’s size or importance. Neoliberalism seeks to limit the state’s direct role in economic activity through privatization, deregulation, private enterprise, and market competition. Yet, as David Harvey shows, markets do not operate independently of the state. They require laws, property rights, contracts, institutions, and rules that shape competition. When markets produce monopoly, environmental costs, unequal power, or other failures, the state may again need to intervene. This creates the central paradox of the neoliberal state. The state may withdraw from activities it once controlled while still using considerable political, legal, and institutional power to establish and protect the market system. In practice, governments may also depart from free-market principles when political, economic, or strategic interests demand it. The result is not the disappearance of the state, but a transformation in how state power is exercised.

Therefore, a smaller state should not automatically be understood as a weaker state. Under neoliberalism, what changes is not just the amount of state power, but its direction and function. The state may own less, manage less, and intervene less directly, while still remaining essential to markets. The real paradox is that a system built around limiting state intervention continues to depend on the state to create, protect, and maintain the conditions that make that limited intervention possible.

References 

Harvey, D. (2005). A brief history of neoliberalism. Oxford University Press.