Thursday 29 Jun 2017 | 17:43 | SYDNEY
Thursday 29 Jun 2017 | 17:43 | SYDNEY

No consensus on the Washington Consensus

World Bank Headquarters in Washington (Photo: Flickr/ Daniel_Afanador)

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COMMENTS

7 June 2017 13:26

Sam Roggeveen's discussion with Allan Gyngell is a reminder that the Washington Consensus means different things to different people. Let's try to sort out the diverse interpretations.

As originally formulated by John Williamson, there were 10 principles which, he believed, would find widespread acceptance as a sensible starting point for economic policy in Latin America:

  • Fiscal discipline
  • Re-ordering public expenditures, away from subsidies and towards education, health and other expenditures
  • Tax reform, emphasising broadly-based taxes
  • Liberalising interest rates, allowing financial markets to allocate credit, instead of government-directed lending.
  • A competitive exchange rate
  • Trade liberalisation
  • Liberalise foreign direct investment (FDI)
  • Deregulation
  • Property rights.
     

This list, put forward in 1989, was not a new program of reform, but rather an attempt to encapsulate principles which were already in place in most Latin American economies. They were so well accepted that they were, in fact, like ‘motherhood and apple pie'. By 1989 no Latin American policy-makers thought that an inflation tax was a good way of raising revenue; that import substitution would foster successful industrial development and correct balance of payments deficits; that fiscal policy should embrace supply-side tax cuts; or that the government should dominate the commanding heights of the economy through ownership of commercial business and five-year plans. Often enough politics over-rode good economics, but the direction of reform was clear. Where countries departed (for example Argentina regarding exchange rate and fiscal policy or Venezuela on nationalisation), the outcome was predictably disastrous. These principles were not intended to be an exhaustive compilation of all good development ideas: just the ones on which there was a broad consensus.

Concurrently, others were pursuing a wider neo-liberal manifesto, encompassing monetarism, low taxes without progressivity in rates, minimal social programs and a diminished role for the state. Encouraged by the success of the Thatcher/Reagan policies of greater reliance on markets and smaller government, these advocates sought to bring this free-market revolution to emerging economies. Capital markets (not just FDI) should be opened up: financial markets should be developed quickly, budgets should not only be disciplined, but should be small. While Williamson had advocated deregulation of barriers to international trade and to competition, others wanted a wider deregulation agenda: reducing rules which protected consumers or the environment and freeing banks from intrusive supervision which might constrain expansion. Despite Williamson's protests, this neo-liberal agenda insinuated itself into the Washington Consensus nomenclature. He ‘lost control over the brand'. This is the version of the Washington Consensus Paul Keating recently attacked.

Williamson's 10 principles certainly included more than one mention of liberalisation and did not claim to be a comprehensive development prescription. This left open opportunity for others to append their own pet views. The hard-edged doctrinal version was not confined just to the University of Chicago and the Mount Pelerine Society. Among the staff and the executive board of the IMF and World Bank many supported this harder-edged agenda, prodded by the economic zeitgeist of the time. Even mainstream economists such as Stan Fischer (initially at the World Bank, later the leading IMF official during the Asian Crisis) argued strongly in favour of full capital-account opening and freely floating exchange rates.

The 1997 Asian Crisis demonstrated that volatile capital flows could cause catastrophic damage; that fast-growing financial sectors were inevitably fragile and subject to calamitous crises; and that free exchange rates could wildly overshoot any notion of equilibrium. Even so, this proselytising advocacy hardly changed. In September 1997, as Asian economies were being whip-sawed by volatile capital flows, the Fund was trying to have its Articles amended to give it a stronger role in promoting free capital flows. For exchange rates, ‘corner solutions' (either pure free-float or currency-board immutable fix) were strongly advocated, with foreign exchange intervention condemned.

While the 1997 Asian Crisis did little to dent this neo-liberal version of the Consensus, the 2007-08 Global Financial Crisis made it harder (perhaps impossible) to ignore the vulnerabilities of financial sectors which were not competently regulated and supervised. 2008 was, to a large degree, a consequence of deficient regulation. Financial supervisors had failed to constrain excessive credit growth, leverage, asset booms, and mis-matches (both maturity and currency). Even Alan Greenspan, the high-priest of financial deregulation, confessed his belated recognition that financial markets were not self-correcting through the self-interest of the private participants. At the 2009 G20 meeting, UK Prime Minister Gordon Brown declared the Washington Consensus to be dead.

But this was the cuckold version, where neo-liberal doctrine had forced its way in. The original Williamson version has been largely incorporated into policy-making not only in Latin America but in Asia as well. Even China and Vietnam could be seen as largely conforming – they did not abolish their state-owned enterprises, but corporatised them to make them responsive to market pressures; exchange rates respond to markets, even if there is intervention to iron-out large market swings; interest rates are the market-clearing method of allocating credit; and budgets are constrained by the need for balance.

The Consensus came under attack from another direction: those who thought it was an overly-narrow response to the challenge of economic development. Williamson readily acknowledged this, and endorsed an additional list which covered a wider range of development priorities, including income distribution and sustainability issues. In retrospect, his main regret was the absence, in the original version, of strong recommendations on institution-building principles. To the extent that the Consensus has not fulfilled its promise of faster development, crises (both financial and external) provide the main explanation. Asia's current response to crisis-risk is unsatisfactory: slower growth and self-insurance through large foreign exchange reserves.

What's in a name? Perhaps it doesn't matter that the sensible version of the Washington Consensus was high-jacked by those with a doctrinal agenda and by their self-serving Wall Street acolytes who profited hugely from poorly regulated financial markets. This hard-edged version made the concept of the Washington Consensus an easy target for those (like Paul Keating) who did not share its right-wing message. But discarding the concept is also a rejection of the idea that there are some core universal truths (or at least very strong presumptions) about sensible economics. One result of this economic-policy nihilism, seen in America today, is a President who advocates nonsensical international trade policies, sees lower taxes for the rich as the secret of growth and - ignoring the lessons of the 2008 Great Recession - is ready to undo the Dodd-Frank Act which made the financial system less risky. To this dismal list we can now add a further element: that the global environment should be left up to the tender mercies of the market.

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