Building support for a new unifying economic paradigm to replace the discredited Washington Consensus will be an analytically challenging, politically demanding, and timeconsuming process. In the meantime, both economists and policymakers must ensure that the existing paradigm doesn’t cause more damage than it already has.
For decades, the Western world put its faith in a welldefined and broadly accepted economic paradigm with applications at both the national and global levels. But, against a background of declining confidence in the ability of “experts” to explain, let alone predict, economic developments, that faith has deteriorated. With a new paradigm having yet to emerge, the world economy faces a heightened risk of fragmentation, with already-vulnerable countries being left even further behind.
The paradigm that, until recently, dominated much of economic thinking and policymaking is embodied in the so-called Washington Consensus a set of ten broadly applicable policy prescriptions for individual countries and, at the international level, in the pursuit of economic and financial globalization. The idea, simply put, was that countries would benefit from embracing market-based pricing and deregulation at home, while fostering free trade and relatively open cross-border capital flows.
Deepening the economic and financial linkages among countries was viewed as the best way to deliver durable gains, enhance efficiency and productivity, and mitigate the threat of financial instability. This approach was also deemed to yield collateral benefits, from enhancing internal social mobility to reducing the risk of violent conflict among countries. And it promised to support the positive convergence of developing and developed countries, thereby reducing both absolute and relative poverty and weakening economic incentives for illegal crossborder migration.
Supported by the traditional economic theories taught at most universities, this approach was energized after the fall of the Berlin Wall and the disintegration of the Soviet Union, when the former communist countries, together with China, joined the Western-dominated world order, boosting total production and consumption.
But, at a certain point, confidence in the Washington Consensus turned into something like blind faith. The resulting complacency, among policymakers and economists alike, contributed to the world economy becoming more vulnerable to a series of small shocks that, in 2008, culminated in a crisis that pushed the world to the brink of a devastating multiyear economic depression.
Suddenly, the advantages of globalization paled in comparison to the risks. It didn’t help that the crisis originated in the United States, which had hitherto been the main advocate for the Washington Consensus and unbridled globalization, including through its role in multilateral organizations like the G7, the International Monetary Fund, the World Bank, and the World Trade Organization.
Analytical failures were partly to blame for this. The economics profession did not go far enough to develop a comprehensive understanding of the connection between a rapidly growing and increasingly deregulated financial sector and the real economy. The impact of major technological innovations was poorly understood.
And insights from behavioral science were inadequately regarded if not shunned altogether in favor of analytically elegant microeconomic underpinnings that were model-friendly, but unrealistic and overly simplistic.
Meanwhile, policymakers overlooked the economic, political, and social consequences of rising inequality not just of income and wealth, but also of opportunity, thereby allowing the middle class gradually to be hollowed out, a trend that was exacerbated by both technological and non-technological developments. They also underestimated the risks of financial contagion and surges in migration flows. As a result, behavioral norms and rules lagged far behind realities on the ground, and political polarization intensified.
At the international level, the established post-war order was increasingly challenged by a rising China, whose sheer size, in terms of both geography and population, enabled it to achieve systemic importance, despite a relatively low per capita income and a political system that seemed at odds with a liberal market-based economy. The major global economic institutions struggled to adapt quickly enough.
In fact, notwithstanding a few tweaks, the governance structure of the IMF and the World Bank remained more reflective of past realities, with Europe, in particular, maintaining disproportionate influence. Even the G20, which emerged when the G7 proved too narrow and exclusive to support effective economic-policy coordination, failed to change the game. A lack of operational continuity, together with disagreements among countries, quickly undermined the G20’s effectiveness, especially after the threat of a global depression had passed.
Given all this, it should come as no surprise that enthusiasm for economic and financial globalization has faltered. Indeed, both advanced and emerging economies have long balked at the notion of strengthening regional and international institutions by delegating more national authority to them.
Now, some countries are adopting a more inward-looking approach and/or shifting their focus to bilateral and, in Asia, to regional linkages. Such shifts give larger economies like the US and China a distinct advantage, while some economies and regions particularly in Africa face increasing marginalization.
Building consensus around a revised unifying paradigm will not be easy. It will be an analytically challenging, politically demanding, and time-consuming process that will probably entail the consideration and rejection of a few bad ideas before good ones take root. It will also be a more multidisciplinary and intellectually inclusive process more bottom-up than top-down than the one that preceded it. It will need to adapt intelligently to innovations in artificial intelligence, Big Data, and mobility.
In the meantime, both economists and policymakers have an important role to play in improving the existing situation. At the international level, the concept of “fair trade” not to mention social displacement should be a bigger part of policy discussions. And economies, especially Europe, need to work actively to reform a tired system of multilateral governance that increasingly lacks credibility.
Moreover, feedback loops between the real economy and finance need to be examined in greater depth. Distributional issues, including pressures on the middle class and the predicament of population segments vulnerable to slipping through stretched social safety nets, need to be better understood and addressed. This demands deeper comprehension of technology-driven structural changes, with Big Tech recognizing and adjusting to its growing systemic importance in step with government.
Complacency was a central reason for the last economic paradigm’s loss of credibility. Let us not allow it to do any more damage than it already has.
Mohamed A. El-Erian, Chief Economic Adviser at Allianz, the corporate parent of PIMCO where he served as CEO and co-Chief Investment Officer, was Chairman of US President Barack Obama’s Global Development Council.
GOODBYE WASHINGTON CONSENSUS, HELLO WASHINGTON CONFUSION? Dani Rodrik
Harvard University January 2006
Life used to be relatively simple for the peddlers of policy advice in the tropics. Observing the endless list of policy follies to which poor nations had succumbed, any well trained and well intentioned economist could feel justified in uttering the obvious truths of the profession: get your macro balances in order, take the state out of business, give markets free rein.
“Stabilize, privatize, and liberalize” became the mantra of a generation of technocrats who cut their teeth in the developing world and of the political leaders they counseled.
Codified in John Williamson’s (1990) well known Washington Consensus, this advice inspired a wave of reforms in Latin America and Sub Saharan Africa which fundamentally transformed the policy landscape in these developing areas. With the fall of the Berlin Wall and the collapse of the Soviet Union, former socialist countries similarly made a bold leap towards markets. There was more privatization, deregulation and trade liberalization in Latin America and Eastern Europe than probably anywhere else at any point in economic history.
In SubSaharan Africa governments moved with less conviction and speed, but there too a substantial portion of the new policy agenda was adopted: state marketing boards were dismantled, inflation reduced, trade opened up, and significant amounts of privatization undertaken.
Such was the enthusiasm for reform in many of these countries that Williamson’s original list of do’s and don’ts came to look remarkably tame and innocuous by comparison. In particular, financial liberalization and opening up to international capital flows went much farther than what Williamson had anticipated (or thought prudent) from the vantage point of the late 1980s. Williamson’s (2000) protestations notwithstanding, the reform agenda eventually came to be perceived, at least by its critics, as an overtly ideological effort to impose “neoliberalism” and “market fundamentalism” on developing nations.
The one thing that is generally agreed on about the consequences of these reforms is that things have not quite worked out the way they were intended. Even their most ardent supporters now concede that growth has been below expectations in Latin America (and the “transition crisis” deeper and more sustained than expected in former socialist economies). Not only were success stories in Sub Saharan Africa few and far in between, but the market oriented reforms of the 1990s proved ill suited to deal with the growing public health emergency in which the continent became embroiled. The critics, meanwhile, feel that the disappointing outcomes have vindicated their concerns about the inappropriateness of the standard reform agenda. While the lessons drawn by proponents and skeptics differ, it is fair to say that nobody really believes in the Washington Consensus anymore. The question now is not whether the Washington Consensus is dead or alive; it is what will replace it.
The World Bank’s Economic Growth in the 1990s: Learning from a Decade of Reform (2005, henceforth Learning from Reform) is one of a spate of recent attempts at making sense of the facts of the last decade and a half, and probably the most intelligent. In fact, it is a rather extraordinary document insofar as it shows how far we have come from the original Washington Consensus. There are no confident assertions here of what works and what doesn’t, no blueprints for policy makers to adopt. The emphasis is on the need for humility, for policy diversity, for selective and modest reforms, and for experimentation.
“The central message of this volume,” Gobind Nankani, the World Bank vice president who oversaw the effort, writes in the preface of the book, “is that there is no unique universal set of rules. . .. We need to get away from formulae and the search for elusive ‘best practices’. Occasionally, the reader has to remind himself that the book he is holding in his hands is not some radical manifesto, but a report prepared by the seat of orthodoxy in the universe of development policy.
Here is how Learning from Reform summarizes the surprises of the 1990s:
First, there was an unexpectedly deep and prolonged collapse in output in countries making the transition from communism to market economies. More than a decade into the transition, many countries had still not caught up to their 1990 levels of output.
Second, Sub Saharan Africa failed to take off, despite significant policy reform, improvements in the political and external environments, and continued foreign aid. The successes were few with, Uganda, Tanzania, and Mozambique the most commonly cited instances, and remained fragile more than a decade later.
Third, there were frequent and painful financial crises in Latin America, East Asia, Russia, and Turkey. Most had remained unpredicted by financial markets and economists until capital flows started to reverse very suddenly.
Fourth, the Latin American recovery in the first half of the 1990s proved short lived. The 1990s as a whole saw less growth in Latin America in per capita GDP than in 1950. So, despite the dismantling of the state led, populist, and protectionist policy regimes of the region. Finally, Argentina, the poster boy of the Latin American economic revolution, came crashing down in 2002 as its currency board proved unsustainable in the wake of Brazil’s devaluation in January 1999.
Significantly, the period since 1990 was not a disaster for economic development. Quite to the contrary. From the standpoint of global poverty, the last two decades have proved the most favorable that the world has ever experienced. Rapid economic growth in China, India, and a few other Asian countries has resulted in an absolute reduction in the number of people living in extreme poverty.
The paradox is that that was unexpected too! China and India increased their reliance on market forces, of course, but their policies remained highly unconventional. With high levels of trade protection, lack of privatization, extensive industrial policies, and lax fiscal and financial policies through the 1990s, these two economies hardly looked like exemplars of the Washington Consensus. Indeed, had they been dismal failures instead of the successes they turned out to be, they would have arguably presented stronger evidence in support of Washington Consensus policies.
Along with this telling, with anecdotal evidence has come a more skeptical reading of the cross national relationship between policy reform and economic growth. Characteristically, it is the World Bank itself that has been prone to make grandiose claims on the impact of policy reform. In one particularly egregious instance cited by Easterly (2005), Collier and Dollar (2001) argued that policy reform of the conventional type could cut world poverty by half. Work by Easterly (2005) and Rodriguez (2005) show that the data do not support such claims. The evidence that macroeconomic policies, price distortions, financial policies, and trade openness have predictable, robust, and systematic effects on national growth rates is quite weak, except possibly in the extremes. Humongous fiscal deficits or autarkic trade policies can stifle economic growth, but moderate amounts of each are associated with widely varying economic outcomes.
The question is how to interpret this recent experience, and how to turn the interpretation into concrete policy advice. Here Learning from Reform makes some valuable progress. I summarize some of the main conclusions below, emphasizing those that depart most strongly from the earlier approach.
One of the insights of Learning from Reform is that the conventional package of reforms was too obsessed with deadweight loss triangles and reaping the efficiency gains from eliminating them, and did not pay enough attention to stimulating the dynamic forces that lie behind the growth process. Seeking efficiency gains does not amount to a growth strategy. Although the report does not quite put it in this way, what I think the authors have in mind is that market or government failures that affect accumulation or productivity change are much more costly, and hence are more deserving of policy attention, than distortions that simply affect static resource allocation. They may also be harder to identify. Focusing on the latter instead of the former results in small benefits, and could even turn out to be counterproductive when policy makers face a political budget constraint (more reform in one area means less reform in another).
A second conclusion is that the broad objectives of economic reform, namely market oriented incentives, macroeconomic stability, and outward orientation, do not translate into unique set of policy actions. In the words of the Report, “The principles of ‘macroeconomic stability, domestic liberalization, and openness’ have been interpreted narrowly to mean ‘minimize fiscal deficits, minimize inflation, minimize tariffs, maximize privatization, maximize liberalization of finance,’ with the assumption that the more of these changes the better, at all times and in all places, overlooking the fact that these expedients are just some of the ways in which these principles can be implemented”.
The authors go on to point out that each of these ends can be achieved in a number of ways. For example, trade openness can be achieved through lower import tariffs, but also through duty drawbacks, export subsidies, special economic zones, export processing zones, and so on. This renunciation of standard “best practice” in World Bank policy advice is quite remarkable, and must not have come without a significant internal fight.
Third, different contexts require different solutions to solving common problems. Enhancing private investment incentives may require improving the security of property rights in one country, but enhancing the financial sector in another. Technological catch up may call for better or worse patent protection, depending on the level of development. This explains why countries that are growing, the report cites Bangladesh, Botswana, Chile, China, Egypt, India, Lao PDR, Mauritius, Sri Lanka, Tunisia, and Vietnam, have such diverse policy configurations, and why attempts to copy successful policy reforms in another country often end up in failure.
Fourth, Learning from Reform argues that there has been a tendency to exaggerate the advantages of rules over discretion in government behavior. Rules were meant to discipline the malfeasance of governments. But it turns out that “government discretion cannot be bypassed”. Argentina’s currency board, which removed monetary policy from the hands of the government, worked well when the binding constraint was lack of credibility, but led to disastrous outcomes when the binding constraint became an overvalued currency. There is no alternative to improving the processes of decision making (better checks and balances, better guiding principles, better implementation) such that discretion leads to better outcomes.
Finally, reform efforts need to be selective and focus on the binding constraints on economic growth rather than take a laundry list approach a la Washington Consensus. While there is no foolproof method of identifying these constraints, common sense and economic analysis can help. When investment is constrained by poor property rights, improving financial intermediation will not help. When it is constrained by high cost of capital, improving institutional quality will hardly work. Experimentation and learning about the nature of the binding constraints, and the changes therein, are therefore an integral part of the reform process. Even though countries may face situations in which many constraints need to be addressed simultaneously. the report judges these situations to be rare: “In most cases, countries can deal with constraints sequentially, a few at a time”.
Taking these conclusions at face value, what they entail is nothing less than a radical rethink of development strategies. Of course, it would be naive to think that the World Bank’s practice will therefore change overnight. There is little evidence that operational work at the Bank has internalized these lessons to any significant extent. And, as I will discuss below, there are contending interpretations of what has gone wrong and how to move forward. But the mere fact that such views have been put forward in an official World Bank publication is indicative of the changing nature of the debate and of the space that is opening up within orthodox circles for alternative visions of development policy.
The alternatives. 12 institutions
Around the same time that the World Bank was grappling with the lessons of the 1990s, its sister institution across the street, the International Monetary Fund, put out a document that focused on much the same issues in the context of Latin America. This is an equally remarkable document which shows that in Washington there is anything but consensus these days. The IMF report starts from the same basic premise, growth has been disappointing, but its basic argument could not be more different. According to its authors, the problem was not with the approach taken to reform, but that it did not go deep and far enough. Using the report’s own words, “reforms were uneven and remained incomplete”. “More progress was made,” the IMF report claims, “with measures that had low up front costs, such as privatization, relative to reforms that promised greater long term benefits, such as improving macroeconomic and labor market institutions, and strengthening legal and judicial systems”. The same diagnosis is expressed succinctly in the title of one of Anne Krueger’s speeches on policy reform: “Meant well, tried little, failed much”.
From this perspective, the failures have to be chalked up to too little reform of the kind that Washington has advocated all along, and not to the nature of these reforms itself. The policy implication that follows is simple: do more of the same, and do it well.
Several key ideas underpin this interpretation of the evidence, First, political leaders may have had the talk, but they didn’t quite have the walk: their commitment to genuine reform was often “skin deep” and there was “lack of follow through”. Second, and more fundamentally, even committed reformers stopped well short of undertaking the full gamut of institutional changes needed to create well functioning market economies. Regulatory and supervisory institutions in product and financial markets proved too weak. Poor governance and corruption remained a problem. Courts and the judiciary were ineffective. And labor market institutions were not sufficiently “flexible.”
Of course this second point, about the lack of emphasis on institutional reform, is itself an implicit repudiation of the original version of the Washington Consensus, insofar as the latter did not feature institutional reform of the type that Krueger and the IMF have in mind in their interpretation of the 1990s. Most of the items in Williamson’s original list were relatively simple policy changes (liberalize trade, eliminate currency overvaluation, reduce fiscal deficits, and so on) that did not require deep seated institutional changes. Williamson did include “property rights” in his list, but that was the last item on the list and came almost as an afterthought.
What has become clearer to practitioners of the Washington Consensus over time is that the standard policy reforms did not produce lasting effects if the background institutional conditions were poor. Sound policies needed to be embedded in solid institutions. Moreover, there were significant complementarities across different areas of reform. Trade liberalization would not work if fiscal institutions were not in place to make up for lost trade revenue, capital markets did not allocate finance to expanding sectors, customs officials were not competent and honest enough, labor market institutions did not work properly to reduce transitional unemployment, and so on.
The upshot is that the original Washington Consensus has been augmented by a long list of so called “second generation” reforms that are heavily institutional in nature. The precise enumeration of these requisite institutional reforms depends on who is talking and when, and often the list seems to extend to whatever it is that the reformers may not have had a chance to do, which is one of the problems that I will discuss below. Nonetheless, one possible rendition is shown in Table l, where I have listed ten second generation reforms to maintain symmetry with the original Washington Consensus.
This focus on institutions has also received a strong boost from the (largely unrelated) rediscovery of institutions as a driver of long term economic performance in the empirical literature on economic growth. In particular, Acemoglu, Johnson, and Robinson’s (2001) important work drove home the point that the security of property rights has been historically perhaps the single most important determinant of why some countries grew rich and others remained poor. Going one step further, Easterly and Levine (2003) showed that policies (i.e., trade openness, inflation, and exchange rate overvaluation) do not exert any independent effect on long term economic performance once the quality of domestic institutions is included in the regression.
Often, this work has taken a form that may be called “institutions fundamentalism” to relate it to (and distinguish it from) the earlier wave of “market fundamentalism.” Getting the institutions right is the mantra of the former, just as getting prices right was the mantra of the latter. The Augmented Washington Consensus derives its academic support largely from this work on the primacy of institutions.
Taken to its logical conclusion, the focus on institutions has potentially debilitating side effects for policy reformers. Institutions are by their very nature deeply embedded in society. If growth indeed requires major institutional transformation, in the areas of rule of law, property rights protection, governance, and so on, how can we not be pessimistic about the prospects for growth in poor countries? After all, such institutional changes typically happen very rarely perhaps in the aftermath of war, civil wars, revolutions, and other major political upheavals. The cleanest cases that link institutional change to growth performance occur indeed at such historical junctures: consider for example the split between East and West Germany, or of North and South Korea. But what are poor countries that do not want to go through such upheavals to do?
Learning from Reform pays lip service to the importance of institutions, but to its credit it steers clear from too much institutions determinism. That is wise because the Augmented Washington Consensus’ focus on institutional change proves to be largely a dead end upon closer look. There are two major reasons for this, which I summarize here.
First, the cross national literature has been unable to establish a strong causal link between any particular design feature of institutions and economic growth. We know that growth happens when investors feel secure, but we have no idea what specific institutional blueprints will make them feel more secure in a given context. The literature gives us no hint as to what the right levers are. Institutional function does not uniquely determine institutional form. If you think this is splitting hairs, just compare the experience of Russia and China in the mid 1990s. China was able to elicit inordinate amounts of private investment under a system of state ownership (township and village enterprises), something that Russia failed to do under Western style private ownership. Presumably this was because investors felt more secure when they were allied with local governments with residual claims on the stream of profits than when they had to entrust their assets to private contracts that would have to be enforced by incompetent and corrupt courts. Whatever the underlying reason, China’s experience demonstrates how common goals (protection of property rights) can sometimes be achieved under divergent rules. This is a theme that Learning‘ from Reform loudly trumpets.
Second, we should not forget that Acemoglu et al.’s work and other related research focused on long term economic performance. The typical dependent variable in this line of literature is the level of income in some recent year, not the rate of economic growth over a particular period. When institutional indicators are introduced in growth regressions, the results are much weaker and less robust.
Empirical work focusing on transitions into and out of growth has found little evidence that large scale institutional transformations play a role.
To take two important examples, China embarked on rapid growth in the late 1970s with changes in its system of incentives that were marginal in nature (and certainly with no ownership reform or significant change in its trade regime early on), and India’s transition to high growth in the early 1980s was preceded (or accompanied) by no identifiable institutional changes. These and other experiences suggest that a policy maker interested in igniting economic growth may be better served by targeting the most binding constraints on economic growth, where the bang for the reform buck is greatest, than by investing scarce political and administrative capital on ambitious institutional reforms. Of course, institutional reform will be needed eventually to sustain economic growth. But it may be easier and more effective to do that when the economy is already growing and its costs can be spread over time.
In the limit, the obsession with comprehensive institutional reform leads to a policy agenda that is hopelessly ambitious and virtually impossible to fulfill. Telling poor countries in Africa or Latin America that they have to set their sights on the best practice institutions of the US. or Sweden is like telling them that the only way to develop is to become developed hardly useful policy advice!
Furthermore, there is something inherently unfalsifiable about this advice. So open ended is the agenda that even the most ambitious institutional reform efforts can be faulted ex post for having left something out. So you reformed institutions in trade, property rights, and macro, but still did not grow? Well, it must be that you did not reform labor market institutions. You did that too, but still did not grow? Well, the problem must be with lack of safety nets and inadequate social insurance. You reformed those, with little effect? Obviously the problem was that your political system was unable to generate sufficient credibility, lock in, and legitimacy for the reforms. In the end, it is always the advisee who falls short, and never the advisor who is proved wrong.
The alternatives II: foreign aid
Yet another vision of reform strategy is offered by the United Nations’ Millennium Project, led by Jeffrey Sachs. This vision is no less holistic than that of the institutions fundamentalists, although the elements of the package and the weight placed on each differ.
The UN. Project calls for a comprehensive and simultaneous increase in “public investments, capacity building, domestic resource mobilization, and official development assistance,” while providing “a framework for strengthening governance, promoting human rights, engaging civil society, and promoting the private sector”.
But it also abounds in concrete details of what can and should be done. Some of the “quick win actions” it proposes include free distribution of bed nets against malaria, ending user fees for primary education and essential health services, expansion of school meals programs in hunger zones, and replenishment of soil nutrients on smallholder agriculture through subsidized or free distribution of chemical fertilizers.
The UN Millennium Project views current levels of foreign aid to be a significant constraint on the achievement of global poverty reduction. Hence it calls for a significant increase in aid, a doubling of annual official development assistance to $135 billion in 2006, rising to $195 billion by 2015, to finance public investments in human capital and infrastructure and to develop the technologies needed to transform health and agriculture in poor societies.
Sachs and his collaborators exhibit a certain impatience with those who argue that the real constraint is poor institutions and weak governance, and that large aid flows are more likely to disappear in the pockets of corrupt officialdom than to foster development. They argue that many of the poorest countries of the world (e.g., Benin, Mali, Senegal) have in fact made significant strides in improving their economic and political institutions, and that in any case the investments in human capital that they advocate would likely foster better institutions as well. In their view, the obsession with governance is often just an excuse for rich countries not doing more to help poor nations.
The theory underlying the UN Millenium Project’s view of the world is that low income countries in Africa (and possibly elsewhere) are stuck in a low level equilibrium, a “poverty trap”.
The neoclassical production function assumes that the marginal product of capital is high at low levels of development (when the economy has low levels of capital). But if there are some increasing returns to scale (e.g., setting up a modern factory requires a minimum investment to be made), complementarities (e.g., running a modern factory needs an adequate supply of educated workers), or negative feedback effects (e.g., an increase in incomes raises population growth), the marginal return to capital is initially low rather than high. Small increments to capital yield very little fruit, and the economy can have multiple steady states, one of which involves a poverty trap. Since it does not pay to invest, households do not save and the economy remains poor.
This very old idea (going back at least to Rosenstein Rodan (1943) and Nelson (1956)) can be used to justify a “big push”, i.e., a large scale, simultaneous effort to raise the capital stock (public, private, human) to levels where the neoclassical forces of convergence begin to operate and the economy breaks free of the poverty trap.
Several questions are raised by this take on African poverty. First, what do we make of the fact that historically few low income countries have embarked on high growth in this big push fashion or through the infusion of large amounts of foreign aid? As Sachs’ critics love to point out, there has not been a shortage of foreign aid in Africa, and some of the most rapidly growing countries of the past have done so without relying much on Western aid. Sachs and his collaborators counter that Africa is special because it suffers from high transport costs, low productivity agriculture, a very heavy disease burden, adverse geopolitics, and slow diffusion of technology from abroad, all of which make the region particularly prone to a poverty trap. But couldn’t one have said much the same of Vietnam, a war torn, impoverished country facing economic sanctions from the United States, which took off in the late 1980s even though it did not receive much aid from Western nations until the mid 1990s?
Or what do we make of the fact that economic growth is actually not uncommon among Sub Saharan African nations themselves? The theory of poverty traps suggests that these countries are stuck in low level equilibria from which they find it very hard to extricate themselves. The reality seems to be somewhat different. Most African countries have shown themselves capable of producing economic growth over non trivial time horizons.
A telling statistic produced by Jones and Olken (2005) is that three quarters of Sub Saharan African countries have grown fast enough to experience some convergence with US. income levels over at least one 10 year period since 1950. Similarly, in Hausmann. Pritchett, and Rodrik (2005), where we studied growth accelerations since the 1950s, we found such accelerations to be quite frequent in low income countries, including among those in Africa. In fact, growth accelerations turned out to be more common in low income countries than in middle or high income countries, in line with the neoclassical growth model. The trouble seems to be not that poor African countries are unable to grow, but that their growth spurts eventually fizzle out. This suggests a rather different remedy, one that focuses in the short run on selectively removing binding constraints on growth (which may well differ from country to country), and in the medium to longer run on enhancing resilience to external shocks. I will elaborate on this remedy below.
Ultimately, where the UN. Millennium Project differs most from Learing from Reform is in the extent of knowledge that it assumes we have and consequently in the degree of self confidence exhibited by its authors. The UN. Millennium Project is based on the view that we basically know enough to mount a bold, ambitious, and costly effort to eradicate world poverty. We have successfully identified all the margins that matter, and we better move on all of them simultaneously.
Learing from Reform, by contrast, is an ode to humility. What we have learned. it says implicitly, is the folly of assuming that we know too much. We need to downplay grandiose claims, move cautiously, and concentrate our efforts where the payoffs seem the greatest.
A practical agenda for formulating growth strategies
But what is the operational content of such a cautious, experimentalist approach? If we adopt the path recommended by Learning from Reform can we say anything more than “different strokes for different folks” or avoid a nihilistic attitude where “everything goes”? Learing from Reform says little that is useful on this, but I think the answer is “yes” to both questions.
Let me briefly outline here a way of thinking about growth strategies that avoids some of the obvious pitfalls.
This approach consists of three sequential elements:
First, we need to undertake a diagnostic analysis to figure out where the most significant constraints on economic growth are in a given setting.
Second, we need creative and imaginative policy design to target the identified constraints appropriately.
Third, we need to institutionalize the process of diagnosis and policy response to ensure that the economy remains dynamic and growth does not fizzle out.
Step 1: Growth diagnostics
Policy reforms of the (Augmented) Washington Consensus type are ineffective because there is nothing that ensures that they are closely targeted on what may be the most important constraints blocking economic growth. The trick is to find those areas where reform will yield the greatest return. Otherwise, policy makers are condemned to a spray gun approach: they shoot their reform gun on as many potential targets as possible, hoping that some will turn out to be the ones they are really after.
A successful growth strategy, by contrast, begins by identifying the most binding constraints.
But can this be done? In Hausmann, Rodrik, and Velasco (2005), we develop a framework that we believe suggests a positive answer. We begin with a basic but powerful taxonomy. In a low income economy, economic activity must be constrained by at least one of the following two factors: either the cost of finance must be too high, or the private return to investment must be low. If the problem is with low private returns, that in turn must be due either to low economic (social) returns, or to a large gap between social and private returns (low private appropriability). The first step in the diagnostic analysis is to figure out which of these conditions more accurately characterizes the economy in question.
Fortunately, it is possible to make progress because each of these syndromes throws out different sets of diagnostic signals or generate different patterns of co movements in economic variables. For example, in an economy that is constrained by cost of finance we would expect real interest rates to be high, borrowers to be chasing lenders, the current account deficit to be as large as the foreign borrowing constraint will allow, and entrepreneurs to be full of investment ideas. In such an economy, an exogenous increase in investible funds, such as foreign aid and remittances, will spur primarily investment and other productive economic activities rather than consumption or investment in real estate. This description comes pretty close to capturing the situation of countries such as Brazil or Turkey, for example.
By contrast, in an economy where economic activity is constrained by low private returns, interest rates will be low, banks will be flush in liquidity, lenders will be chasing after borrowers, the current account will be near balance or in surplus, and entrepreneurs will be more interested in putting their money in Miami or Geneva than in investing it at home. An increase in foreign aid or remittances will finance consumption, housing, or capital flight. These in turn are the circumstances that characterize countries such as El Salvador and Ethiopia.
When we identify low private returns as the culprit, we will next want to know whether the source is low social returns or low private appropriability of those returns. Low social returns can be due to poor human capital, lousy infrastructure, bad geography, or other similar reasons. Once again, we need to be on the lookout for diagnostic signals. If human capital (either because of low levels of education or the disease environment) is a serious constraint, we would expect the returns to education or the skill premium to be comparatively high. If infrastructure is the problem, we would observe the bottlenecks in transport or energy, private firms stepping in to supply the needed services, and so on.
Appropriability problems, ie, a large gap between private and social returns, can in turn arise under two sets of circumstances. One possibility has to do with the policy/institutional environment: taxes may be too high, property rights may be protected poorly, high inflation may generate macro risk, labor capital conflicts may depress production incentives, and so on. Alternatively, the fault may lie with market failures such as technological spillovers, coordination failures, and problems of economic “self discovery” (i.e., uncertainty about the underlying cost structure of the economy; see Hausmann and Rodrik 2003). As usual, we look for the tell tale signs of each of these. Sometimes, the diagnostic analysis proceeds down a particular path not because of direct evidence but because the other paths have been ruled out.
It is possible to carry out this kind of analysis at a much finer level of disaggregation, and indeed any real world application has to be considerably more detailed than the one I have sketched here. But I hope this summary conveys the value of an explicitly diagnostic framework. Even a rudimentary application of these principles can sometimes reveal important gaps or shortcomings in traditional reform packages. For example, when the cost of finance is an important binding constraint (as seems likely in Brazil), institutional improvements aimed at improving the “business climate” (i.e., reducing red tape, lowering taxes, and so on) will be not only ineffective (since the problem does not lie with investment demand), but it can also backfire (since an increase in investment demand will put further upwards pressure on interest rates).
Step 2: Policy design
Once the key problem(s) are identified, we need to think about the appropriate policy responses. The key in this step is to focus on the market failures and distortions associated with the constraint identified in the previous step. The principle of policy targeting offers a simple message: target the policy response as closely as possible on the source of the distortion. Hence if credit constraints are the main constraint, for example, and the problem is the result of lack of competition and large bank spreads, the appropriate response is to reduce impediments to competition in the banking sector.
Simple as it may be, this first best logic often does not work, and indeed can be even counter productive. The reason is that we are necessarily operating in a second best environment, due to other distortions or administrative and political constraints. In designing policy, we have to be on the lookout for unforeseen complications and unexpected consequences.
Let me return to an example from China. Formal ownership rights in China’s township and village enterprises (TVEs) were vested not in private hands or in the central government, but in local governments (townships or villages). From the lens of first best reform, these enterprises are problematic, since if our objective is to spur private investment and entrepreneurship, it would have been far preferable to institute private property rights (as Russia and other East European transition economies did). But the first best logic is not helpful here because a private property system relies on an effective judiciary for the enforcement of property rights and contracts. In the absence of such a legal system, formal property rights are not worth much, as minority shareholders in Russia soon discovered to their chagrin.
Until an effective judiciary is created, it may make more sense to make virtue out of necessity and force entrepreneurs into partnership with their most likely expropriators, the local state authorities. That is exactly what the TVEs did. Local governments were keen to ensure the prosperity of these enterprises as their equity stake generated revenues directly for them. In the environment characteristic of China, property rights were effectively more secure under direct local government ownership than they would likely have been under a private property rights legal regime.
Such examples can be easily multiplied (Rodrik 2005a). As an additional illustration, consider the case of achieving integration with the world economy. Policy makers in countries such as South Korea and Taiwan in the early 1960s and China in the late 1970s had decided that enhancing their countries’ participation in world markets was a key objective. For a western economist, the most direct route would have been to reduce or eliminate barriers to imports and foreign investment. Instead, these countries achieved the same ends (i.e. reduce the anti trade bias of their economic policies) through unconventional means. South Korea and Taiwan employed export targets and export subsidies for their firms. China carved out special economic zones where foreign investors had access to a free trade regime. Policy makers chose these unconventional solutions presumably because they created fewer adjustment costs and put less stress on established social bargains.
Step 3: Institutionalising reform
The nature of the binding constraint will necessarily change over time. For example, schooling may not be a binding constraint initially, but as investment and entrepreneurship pick up, it will likely become one unless the quality and quantity of schools increase over time. In Hausmann, Rodrik, and Velasco (2005), we illustrate this issue using the example of the Dominican Republic. This country was able to spur growth with a number of sector specific reforms that stimulated investment in tourism and maquilas.
But it neglected making the institutional investments required to lend resilience and robustness to economic growth, especially in the area of financial market regulation and supervision. When September 11 led to the drying up of tourist inflows, the country paid a big price. A Ponzi scheme that had developed in the banking sector collapsed, and cleaning up the mess cost the government 20 percentage points of GDP and led the economy into a downward spiral. It turned out that the economy had outgrown its weak institutional underpinnings. The same can be said of Indonesia, where the financial crisis of 1997-98 led to total economic and political collapse. It may yet turn out to be case also of China, unless this country manages to strengthen the rule of law and enhance democratic participation.
What is needed to sustain growth?
Two types of institutional reform seem to become critical over time.
First, there is the need to maintain productive dynamism. Natural resource discoveries, garment exports from maquilas, or a free trade agreement may spur growth for a limited time. Policy needs to ensure that this momentum is maintained with ongoing diversification into new areas of tradables. Otherwise, growth simply fizzles out. What stands out in the performance of East Asian countries is their continued focus on the needs of the real economy and the ongoing encouragement of technology adoption and diversification.
The second area that needs attention is the strengthening of domestic institutions of conflict management. The most frequent cause for the collapse in growth is the inability to deal with the consequences of external shocks, i.e., terms of trade declines or reversals in capital flows. Endowing the economy with resilience against such shocks requires strengthening the rule of law, solidifying (or putting in place) democratic institutions, establishing participatory mechanisms, and erecting social safety nets.
When such institutions are in place, the macroeconomic and other adjustments needed to deal with adverse shocks can be undertaken relatively smoothly. When they are not, the result is distributive conflict and economic collapse (Rodrik 1999). The contrasting experiences of South Korea and Indonesia in the immediate aftermath of the Asian financial crisis in 1997-98 are quite instructive in this regard.
Institutional reforms in these areas are difficult to implement and they take time. Economic science typically provides very little guidance on how to proceed (Dixit 2004). But the point is that these difficulties do not need to stand in the way of formulating less ambitious, more selective, and more carefully targeted policy initiatives that can have very powerful effects on igniting economic growth in the short run. What is required to spur growth should not be confused with what is required to initiate it.
It is now time for a confession. As the preceding discussion ought to have made clear, I find Learning from Reform a useful and important document in no small part because its central themes parallel those that I have been advocating for some time along with a number of my colleagues at the Kennedy School.
It is gratifying to see one’s ideas being taken seriously, particularly by an institution that has frequently served as a target for one’s criticisms. The report pays me compliments in other ways too: one of its two opening quotes is taken from my work (the other is from Al Harberger). And I return the compliment by acting as one of the endorsers on its back cover. Had the editor of this Journal not insisted, I would not have found it proper to write this review essay.
But I would like to think that the laudatory note I have struck above has to do not just with an ego that is being stroked. Coming from the institution that is one of the chief architects of the reforms of the last twenty years, Learing from Reform is a genuinely interesting document: it represents a mea culpa as well as a way forward. It pushes us to think harder and deeper about the economics of reform than anything else out there. It warns us to be skeptical of top down, comprehensive, universal solutions-no matter how well intentioned they may be. And it reminds us that the requisite economic analysis, hard as it is, in the absence of specific blueprints has to be done case by case.
These should be music to any economist’s ears. After all, what distinguishes professional economists from ideologues is that the former are trained to make contingent statements: policy A is to be recommended only if conditions x, y, and z obtain. Sensible advice consists of a well articulated mapping from observed conditions onto its policy implications. This simple, but fundamental principle seems to have gotten lost in much of the thinking on economic reform in the developing world, which has often taken an a priori and mechanical form. Its rediscovery is therefore good news not just for poor nations, but for the economics profession as well.
What is the Washington Consensus?
The Washington Consensus is a set of 10 economic policy prescriptions considered to constitute the “standard” reform package promoted for crisis-wracked developing countries by Washington, DC. based institutions such as the International Monetary Fund (IMF), World Bank, and the US Treasury Department. The term was first used in 1989 by English economist John Williamson“
The prescriptions encompassed policies in such areas as macroeconomic stabilization, economic opening with respect to both trade and investment, and the expansion of market forces within the domestic economy.
Subsequent to Williamson’s use of the terminology, and despite his emphatic opposition, the phrase Washington Consensus has come to be used fairly widely in a second, broader sense, to refer to a more general orientation towards a strongly market-based approach (sometimes described as market fundamentalism or neoliberalism). In emphasizing the magnitude of the difference between the two alternative definitions, Williamson himself has argued that his ten original, narrowly defined prescriptions have largely acquired the status of “motherhood and apple pie” (i.e., are broadly taken for granted), whereas the subsequent broader definition, representing a form of neoliberal manifesto, “never enjoyed a consensus [in Washington] or anywhere much else” and can reasonably be said to be dead.
Discussion of the Washington Consensus has long been contentious. Partly this reflects a lack of agreement over what is meant by the term, in face of the contrast between the broader and narrower definitions.
But there are also substantive differences involved over the merits and consequences of the various policy prescriptions involved. Some critics take issue, for example, with the original Consensus’s emphasis on the opening of developing countries to global markets, and/or with what they see as an excessive focus on strengthening the influence of domestic market forces, arguably at the expense of key functions of the state.
For other commentators the issue is more what is missing, including such areas as institution building and targeted efforts to improve opportunities for the weakest in society.
Despite these areas of controversy, a number of developmental institutions and economists (such as Joseph Stiglitz) would by now accept the more general proposition that strategies best work if they are specifically designed to the certain circumstances of the individual countries.
Original sense: Williamson’s Ten Points
The concept and name of the Washington Consensus were first presented in 1989 by John Williamson, an economist from the Institute for International Economics, an international economic think tank based in Washington, D.C. Williamson used the term to summarize commonly shared themes among policy advice by Washington-based institutions at the time, such as the International Monetary Fund, World Bank, and US. Treasury Department, which were believed to be necessary for the recovery of countries in Latin America from the economic and financial crises of the 198Os.
The consensus as originally stated by Williamson included ten broad sets of relatively specific policy recommendations.
1. Fiscal policy discipline, with avoidance of large fiscal deficits relative to GDP.
2. Redirection of public spending from subsidies (“especially indiscriminate subsidies”) toward broad-based provision of key pro-growth, propoor services like primary education, primary health care and infrastructure investment.
3. Tax reform, broadening the tax base and adopting moderate marginal tax rates.
4. Interest rates that are market determined and positive (but moderate) in real terms.
5. Competitive exchange rates.
6. Trade liberalization: liberalization of imports, with particular emphasis on elimination of quantitative restrictions (licensing, etc.). Any trade protection to be provided by low and relatively uniform tariffs.
7. Liberalization of inward foreign direct investment.
8. Privatization of state enterprises.
9. Deregulation: abolition of regulations that impede market entry or restrict competition, except for those justified on safety, environmental and consumer protection grounds, and prudential oversight of financial institutions.
10. Legal security for property rights.
Origins of policy agenda
Although Williamson’s label of the Washington Consensus draws attention to the role of the Washington-based agencies in promoting the above agenda, a number of authors have stressed that Latin American policy-makers arrived at their own packages of policy reforms primarily based on their own analysis of their countries’ situations. Thus, according to Joseph Stanislaw and Daniel Yergin, authors of The Commanding Heights, the policy prescriptions described in the Washington Consensus were “developed in Latin America, by Latin Americans, in response to what was happening both within and outside the region.”
Joseph Stiglitz has written that “the Washington Consensus policies were designed to respond to the very real problems in Latin America and made considerable sense“ (though Stiglitz has at times been an outspoken critic of IMF policies as applied to developing nations). In view of the implication conveyed by the term Washington Consensus that the policies were largely external in origin, Stanislaw and Yergin report that the term’s creator, John Williamson, has “regretted the term ever since”, stating “it is difficult to think of a less diplomatic label.”
A 2010 paper by Nancy Birdsall, Augusto de la Torre, and Felipe Valencia Caicedo likewise suggests that the policies in the original consensus were largely a creation of Latin American politicians and technocrats, with Williamson’s role having been to gather the ten points in one place for the first time, rather than to “create” the package of policies.
ln Williamson’s own words from 2002:
“It is difiicult even for the creator of the term to deny that the phrase “Washington Consensus” is a damaged brand name. Audiences the world over seem to believe that this signifies a set of neoliberal policies that have been imposed on hapless countries by the Washington based international financial institutions and have led them to crisis and misery. There are people who cannot utter the term without foaming at the mouth.
My own View is of course quite different. The basic ideas that I attempted to summarize in the Washington Consensus have continued to gain wider acceptance over the past decade, to the point where Lula has had to endorse most of them in order to be electable. For the most part they are motherhood and apple pie, which is why they commanded a consensus.”
Williamson recognizes that the term has commonly been used with a different meaning from his original prescription; he opposes the alternative use of the term, which became common after his initial formulation, to cover a broader market fundamentalism or “neoliberal” agenda.
“I of course never intended my term to imply policies like capital account liberalization (…I quite consciously excluded that), monetarism, supply-side economics, or minimal state (getting the state out of welfare provision and income redistribution), which I think of as the quintessentially neoliberal ideas. If that is how the term is interpreted, then we can all enjoy its wake, although let us at least have the decency to recognize that these ideas have rarely dominated thought in Washington and certainly never commanded a consensus there or anywhere much else…”
More specifically, Williamson argues that the first three of his ten prescriptions are uncontroversial in the economic community, while recognizing that the others have evoked some controversy. He argues that one of the least controversial prescriptions, the redirection of spending to infrastructure, health care, and education, has often been neglected. He also argues that, while the prescriptions were focused on reducing certain functions of government (e.g., as an owner of productive enterprises), they would also strengthen government’s ability to undertake other actions such as supporting education and health. Williamson says that he does not endorse market fundamentalism, and believes that the Consensus prescriptions, if implemented correctly, would benefit the poor.
In a book edited with Pedro-Pablo Kuczynski in 2003, Williamson laid out an expanded reform agenda, emphasizing crisis-proofing of economies, “second-generation” reforms, and policies addressing inequality and social issues.
As noted, in spite of Williamson’s reservations, the term Washington Consensus has been used more broadly to describe the general shift towards free market policies that followed the displacement of Keynesianism in the 1970s. In this broad sense the Washington Consensus is sometimes considered to have begun at about 1980.
Many commentators see the consensus, especially if interpreted in the broader sense of the term, as having been at its strongest during the 1990s. Some have argued that the consensus in this sense ended at the turn of the century, or at least that it became less influential after about the year 2000.
More commonly, commentators have suggested that the Consensus in its broader sense survived until the time of the 2008-2009 global financial crisis.“ ”Following the strong intervention undertaken by governments in response to market failures, a number of journalists, politicians and senior officials from global institutions such as the World Bank began saying that the Washington Consensus was dead. These included former British Prime Minister Gordon Brown, who following the 2009 G-20 London summit, declared “the old Washington Consensus is over”.“
Williamson was asked by The Washington Post in April 2009 whether he agreed with Gordon Brown that the Washington Consensus was dead. He responded:
“It depends on what one means by the Washington Consensus. If one means the ten points that I tried to outline, then clearly it’s not right. If one uses the interpretation that a number of people-including Joe Stiglitz, most prominently, have foisted on it, that it is a neoliberal tract, then I think it is right.”
After the 2010 G-20 Seoul summit announced that it had achieved agreement on a Seoul Development Consensus, the Financial Times editorialized that “Its pragmatic and pluralistic” view of development is appealing enough. But the document will do little more than drive another nail into the coffin of a long deceased Washington Consensus.
Many countries have endeavored to implement varying components of the reform packages, with implementation sometimes imposed as a condition for receiving loans from the IMF and World Bank. The results of these reforms are much debated. Some critics focus on claims that the reforms led to destabilization. Some critics have also blamed the Washington Consensus for particular economic crises such as the Argentine economic crisis, and for exacerbating Latin America’s economic inequalities.
Criticism of the Washington Consensus has often been dismissed as socialism and/or anti-globalism. While these philosophies do criticize these policies, general criticism of the economics of the consensus is now more widely established, such as that outlined by US scholar Dani Rodrik, Professor of International Political Economy at Harvard University, in his paper, Goodbye Washington Consensus, Hello Washington Confusion.
The institutions that formed the consensus started softening their insistence on these policies in the 2000s largely due to political pressures surrounding globalization, but any reference of these ideas as a consensus essentially ended in the wake of the 2008 global financial crisis, as market fundamentalism lost favour. Though, it should be noted, that most of the core specific policies are still generally regarded favourably, but the policies have come to be viewed as not preventing nor alleviating acute economic crises.
This is perhaps most notable in the work of the IMF with South Korea to create a new sort of intervention program to the one that South Korea was forced to accept during the Asian Financial Crisis of the late 1990s. That intervention, which was heavily grounded in the Washington Consensus, was hailed at the time for stopping the “Asian Contagion” but eventually the program came to be seen more skepticaly.
Williamson himself has summarized the overall results on growth, employment and poverty reduction in many countries as “disappointing, to say the least”.
He attributes this limited impact to three factors: (a) the Consensus per se placed no special emphasis on mechanisms for avoiding economic crises, which have proved very damaging; (b) the reforms, both those listed in his article and, a fortiori, those actually implemented-were incomplete; and (c) the reforms cited were insufficiently ambitious with respect to targeting improvements in income distribution, and need to be complemented by stronger efforts in this direction.
Rather than an argument for abandoning the original ten prescriptions, though, Williamson concludes that they are “motherhood and apple pie” and “not worth debating”. Both Williamson and other analysts have pointed to longer term improvements in economic performance in a number of countries that have adopted the relevant policy changes consistently, such as Chile.
As Williamson himself has pointed out, the term has come to be used in a broader sense to its original intention, as a synonym for market fundamentalism or neo-liberalism. In this broader sense, Williamson states, it has been criticized by people such as George Soros and Nobel Laureate Joseph E. Stiglitz. The Washington Consensus is also criticized by others such as some Latin American politicians and heterodox economists such as Erik Reinert.
The term has become associated with neoliberal policies in general and drawn into the broader debate over the expanding role of the free market, constraints upon the state, and the influence of the United States, and globalization more broadly, on countries’ national sovereignty.
“Stabilize, privatize, and liberalize” became the mantra of a generation of technocrats who cut their teeth in the developing world and of the political leaders they counseled.” Dani Rodrik
While opinion varies among economists, Rodrik pointed out what he claimed was a factual paradox: while China and India increased their economies’ reliance on free market forces to a limited extent, their general economic policies remained the exact opposite to the Washington Consensus’ main recommendations. Both had high levels of protectionism, no privatization, extensive industrial policies planning, and lax fiscal and financial policies through the 1990s. Had they been dismal failures they would have presented strong evidence in support of the recommended Washington Consensus policies. However they turned out to be successes.
According to Rodrik: “While the lessons drawn by proponents and skeptics differ, it is fair to say that nobody really believes in the Washington Consensus anymore. The question now is not whether the Washington Consensus is dead or alive; it is what will replace it”.
Rodrik’s account of Chinese or Indian policies during the period is not universally accepted. Among other things those policies involved major turns in the direction of greater reliance upon market forces, both domestically and internationally.
In a book edited with Pedro Pablo Kuczynski in 2003, John Williamson laid out an expanded reform agenda, emphasizing crisis-proofing of economies, “second-generation” reforms, and policies addressing inequality and social issues.
The widespread adoption by governments of the Washington Consensus was to a large degree a reaction to the macroeconomic crisis that hit much of Latin America, and some other developing regions, during the 1980s.
The crisis had multiple origins: the drastic rise in the price of imported oil following the emergence of OPEC, mounting levels of external debt, the rise in US (and hence international) interest rates, and consequent to the foregoing problems, loss of access to additional foreign credit.
The import substitution policies that had been pursued by many developing country governments in Latin America and elsewhere for several decades had left their economies ill-equipped to expand exports at all quickly to pay for the additional cost of imported oil (by contrast, many countries in East Asia, which had followed more exportoriented strategies, found it comparatively easy to expand exports still further, and as such managed to accommodate the external shocks with much less economic and social disruption) Unable either to expand external borrowing further or to ramp up export earnings easily, many Latin American countries faced no obvious sustainable alternatives to reducing overall domestic demand via greater fiscal discipline, while in parallel adopting policies to reduce protectionism and increase their economies’ export orientation.
The Washington Consensus, as framed by Williamson, envisaged a largely unilateral process of trade reform, by which countries would lower their non-tariff (especially) and tariff barriers to imports. Many countries, including the majority of those in Latin America, have indeed undertaken significant unilateral trade liberalization over subsequent years, opening their economies to greater import competition while simultaneously increasing the share of exports in their GDP (in parallel, Latin America’s share in global trade has also increased).
A separate agenda-only tangentially related to the Washington Consensus as framed by Williamson, concerns various programs for multilateral trade liberalization, whether at the global (WTO) or regional level, including the North American Free Trade Agreement (NAFTA) and DR-CAFTA agreements.
Most criticism has been focused on trade liberalization and the elimination of subsidies, and criticism has been particularly strident in the agriculture sector. In nations with substantial natural resources, though, criticism has tended to focus on privatization of industries exploiting these resources.
As of the 2000s, several Latin American countries were led by socialist or other left wing governments, some of which-including Argentina and Venezuela, have campaigned for (and to some degree adopted) policies contrary to the Washington Consensus policies. Other Latin American countries with governments of the left, including Brazil, Chile and Peru, in practice adopted the bulk of the policies included in Williamson’s list, even though they criticized the market fundamentalism that these are often associated with.
Also critical of the policies as actually promoted by the IMF have been some US economists, such as Joseph Stiglitz and Dani Rodrik, who have challenged what are sometimes described as the ‘fundamentalist’ policies of the IMF and the US Treasury for what Stiglitz calls a ‘one size fits all’ treatment of individual economies. According to Stiglitz the treatment suggested by the IMF is too simple: one dose, and fast-stabilize, liberalize and privatize, without prioritizing or watching for side effects.
“The reforms did not always work out the way they were intended. While growth generally improved across much of Latin America, it was in most countries less than the reformers had originally hoped for (and the “transition crisis”, as noted above deeper and more sustained than hoped for in some of the former socialist economies). Success stories in Sub-Saharan Africa during the 1990s were relatively few and far in between, and market oriented reforms by themselves offered no formula to deal with the growing public health emergency in which the continent became embroiled. The critics, meanwhile, argue that the disappointing outcomes have vindicated their concerns about the inappropriateness of the standard reform agenda.”
Besides the excessive belief in market fundamentalism and international economic institutions in attributing the failure of the Washington consensus, Stiglitz provided a further explanation about why it failed. In his article “The Post Washington Consensus Consensus”, he claims that the Washington consensus policies failed to efficiently handle the economic structures within developing countries. The cases of East Asian countries such as Korea and Taiwan are known as a success story in which their remarkable economic growth was attributed to a larger role of the government by undertaking industrial policies and increasing domestic savings within their territory. From the cases, the role for government was proven to be critical at the beginning stage of the dynamic process of development, at least until the markets by themselves can produce efficient outcomes.
“The policies pursued by the international financial institutions which came to be called the Washington consensus policies or neoliberalism entailed a much more circumscribed role for the state than were embraced by most of the East Asian countries, a set of policies which (in another simplification) came to be called the development state.”
The critique laid out in the World Bank’s study Economic Growth in the 1990s: Learning from a Decade of Reform (2005) shows how far discussion has come from the original ideas of the Washington Consensus. There is no unique universal set of rules…. We need to get away from formulae and the search for elusive ‘best practices’….”. The World Bank’s new emphasis is on the need for humility, for policy diversity, for selective and modest reforms, and for experimentation.
The World Bank’s report Learning from Reform shows some of the developments of the 1990s. There was a deep and prolonged collapse in output in some (though by no means all) countries making the transition from communism to market economies (many of the Central and East European countries, by contrast, made the adjustment relatively rapidly). More than a decade into the transition, some of the former communist countries, especially parts of the former Soviet Union, had still not caught up to their 1990 levels of output.
Many Sub-Saharan African’s economies failed to take off during the 1990s, in spite of efforts at policy reform, changes in the political and external environments, and continued heavy influx of foreign aid. Uganda, Tanzania, and Mozambique were among countries that showed some success, but they remained fragile. There were several successive and painful financial crises in Latin America, East Asia, Russia, and Turkey. The Latin American recovery in the first half of the 1990s was interrupted by crises later in the decade. There was less growth in per capita GDP in Latin America than in the period of rapid postwar expansion and opening in the world economy, 1950-80. Argentina, described by some as “the poster boy of the Latin American economic revolution”, came crashing down in 2002.
Among other results of the recent global financial crisis has been a strengthening of belief in the importance of local development models as more suitable than programmatic approaches. Some elements of this school of thought were summarized in the idea of a “Beijing Consensus” which suggested that nations needed to find their own paths to development and reform.
Many critics of trade liberalization, such as Noam Chomsky, Tariq Ali, Susan George, and Naomi Klein, see the Washington Consensus as a way to open the labor market of underdeveloped economies to exploitation by companies from more developed economies.
The prescribed reductions in tariffs and other trade barriers allow the free movement of goods across borders according to market forces, but labor is not permitted to move freely due to the requirements of a visa or a work permit. This creates an economic climate where goods are manufactured using cheap labor in underdeveloped economies and then exported to rich First World economies for sale at what the critics argue are huge markups, with the balances of the markup said to accrue to large multinational corporations. The criticism is that workers in the Third World economy nevertheless remain poor, as any pay raises they may have received over what they made before trade liberalization are said to be offset by inflation, whereas workers in the First World country become unemployed, while the wealthy owners of the multinational grow even more wealthy.
Anti-globalism critics further claim that First World countries impose what the critics describe as the consensus’s neoliberal policies on economically vulnerable countries through organizations such as the World Bank and the International Monetary Fund and by political pressure and bribery. They argue that the Washington Consensus has not, in fact, led to any great economic boom in Latin America, but rather to severe economic crises and the accumulation of crippling external debts that render the target country beholden to the First World.
Many of the policy prescriptions (e.g., the privatization of state industries, tax reform, and deregulation) are criticized as mechanisms for ensuring the development of a small, wealthy, indigenous elite in the Third World who will rise to political power and have a vested interest in maintaining the local status quo of labor exploitation.
Some specific factual premises of the critique as phrased above (especially on the macroeconomic side) are not accepted by defenders, or indeed all critics, of the Washington Consensus. To take a few examples, inflation in many developing countries is now at its lowest levels for many decades (low single figures for very much of Latin America). Workers in some factories created by foreign investment are found typically to receive higher wages and better working conditions than exist in many of their own countries’ domestically owned workplaces. Economic growth in much of Latin America in the last few years has been at historically high rates, and debt levels, relative to the size of these economies, are on average significantly lower than they were several years ago.
Despite these macroeconomic advances, poverty and inequality remain at high levels in Latin America. About one in every three people, 165 million in total, still live on less than $2 a day. Roughly a third of the population has no access to electricity or basic sanitation, and an estimated 10 million children suffer from malnutrition.
These problems are not, however, new: Latin America was the most economically unequal region in the world in 1950, and has continued to be so ever since, during periods both of state-directed import-substitution and (subsequently) of market-oriented liberalization.
Some socialist political leaders in Latin America have been vocal and well-known critics of the Washington Consensus, such as the late Venezuelan President Hugo Chavez, Cuban ex President Fidel Castro, Bolivian President Evo Morales, and Rafael Correa, President of Ecuador. In Argentina, too, the recent Justicialist Party government of Néstor Kirchner and his spouse who succeeded him undertook policy measures which represented a repudiation of at least some Consensus policies.
With the exception of Castro, these leaders have maintained and expanded some successful policies commonly associated with the Washington Consensus, such as macroeconomic stability and property rights protection.
But many have also proposed and implemented policies directly opposed to the Washington Consensus: under Chavez, for example, Venezuela partially nationalized the state-run oil company, Petroleos de Venezuela S.A (PdVSA), and with the help of the company’s assets developed several social programs to help the country’s poor. These programs have been credited with the dramatic improvement in quality of life during Chavez’s presidency: the poverty rate dropped from 48.6% in 2002 to 29.5% in 2011, while access to education and healthcare was significantly increased.
Others on the Latin American left take a different approach. Governments led by the Socialist Party of Chile, by Alan Garcia in Peru, by Tabaré Vézquez in Uruguay, and by Luiz Inacio Lula da Silva in Brazil, have in practise maintained a high degree of continuity with the economic policies described under the Washington Consensus (debt-paying, protection to foreign investment, financial reforms, etc.). But governments of this type have simultaneously sought to supplement these policies by measures directly targeted at improving productivity and helping the poor, such as education reforms and subsidies to poor families conditioned on their children staying in school.
Neo-Keynesian and post-Keynesian critics of the Consensus have argued that the underlying policies were incorrectly laid down and are too rigid to be able to succeed. For example, flexible labor laws were supposed to create new jobs, but economic evidence from Latin America is inconclusive on this point. In addition, some argue that the package of policies does not take into account economic and cultural differences between countries.
Some critics have argued that this set of policies should be implemented, if at all, during a period of rapid economic growth and not, as often is the case, during an economic crisis.
Moisés Naim, chief editor of Foreign Policy, has made the argument that there was no ‘consensus’ in the first place. He has argued that there are and have been major differences between economists over what is the ‘correct economic policy’, hence the idea of there being a consensus was also flawed.
Proponents of the “European model” and the “Asian way”
Some European and Asian economists suggest that “infrastructure-savvy economies” such as Norway, Singapore, and China have partially rejected the underlying Neoclassical “financial orthodoxy” that characterizes the Washington Consensus, instead initiating a pragmatist development path of their own ”based on sustained, large-scale, government funded investments in strategic infrastructure projects: “Successful countries such as Singapore, Indonesia, and South Korea still remember the harsh adjustment mechanisms imposed abruptly upon them by the IMF and World Bank during the 1997-1998 ‘Asian Crisis’. What they have achieved in the past 10 years is all the more remarkable: they have quietly abandoned the Washington Consensus by investing massively in infrastructure projects this pragmatic approach proved to be very successful”.
While China invested roughly 9% of its GDP on infrastructure in the 1990s and 2000s, most Western and non-Asian emerging economies invested only 2% to 4% of their GDP in infrastructure assets. This considerable investment gap allowed the Chinese economy to grow at near-optimal conditions while many South American, South Asian, and African economies suffered frequent serious development bottlenecks like poor transportation networks, aging power grids, and mediocre schools.
Renewed calls for protectionism in the United States
Some view the emergence of Trumponomics in the context of the United States presidential election, 2016 as an unprecedented challenge to the Washington Consensus, far more important than the “liberal and New Left” critiques of the past, arguing that the Trump administration has effectively “repudiated in part the canons of globalization and the neoliberal economic orthodoxy of the past 36 years”
Most Latin American countries continue to struggle with high poverty and underemployment. Chile has been offered as an example of a Consensus success story, and countries such as El Salvador and Panama have also shown some positive signs of economic development. Brazil, despite relatively modest rates of aggregate growth, has seen important progress in recent years in the reduction of poverty. This is counterweight, since the last two Brazilian socialist presidents have adjusted modest socialist reforms.
Joseph Stiglitz has argued that the Chilean success story owes a lot to state ownership of key industries, particularly its copper industry, and currency interventions stabilizing capital flows. Many other economists, though, argue that Chile’s economic success is largely due to its combination of sound macroeconomics and market-oriented policies (though the country’s relatively strong public institutions, including one of the better public school systems in the region, also deserve some credit.
There have been claims of discrepancies between the Washington Consensus as propounded by Williamson, and the policies actually implemented with the endorsement of the Washington institutions themselves. For example, the Washington Consensus stated a need for investment in education, but the policies of fiscal discipline promoted by the International Monetary Fund have sometimes in practice led countries to cut back public spending on social programs, including such areas as basic education. Those familiar with the work of the IMF respond that, at a certain stage, countries near bankruptcy have to cut back their public spending one way or another to live within their means. Washington may argue for enlightened choices among different public spending priorities, but in the last analysis it is domestically elected political leaders who ultimately have to make the tough political choices.
A significant body of economists and policymakers argues that what was wrong with the Washington Consensus as originally formulated by Williamson had less to do with what was included than with what was missing. This view asserts that countries such as Brazil, Chile, Peru and Uruguay, largely governed by parties of the left in recent years, did not, whatever their rhetoric, in practice abandon most of the substantive elements of the Consensus. Countries that have achieved macroeconomic stability through fiscal and monetary discipline have been loath to abandon it: Lula, the former President of Brazil (and former leader of the Workers’ Party of Brazil), has stated explicitly that the defeat of hyperinflation was among the most important positive contributions of the years of his presidency to the welfare of the country’s poor, although remaining influence of his policies on tackling poverty and maintaining a steady low rate of inflation are being discussed and doubted in the wake of the Brazilian Economic Crisis currently occurring in Brazil.
These economists and policy-makers would, however, overwhelmingly agree that the Washington Consensus was incomplete, and that countries in Latin America and elsewhere need to move beyond “first generation“ macroeconomic and trade reforms to a stronger focus on productivity-boosting reforms and direct programs to support the poor. This includes improving the investment climate and eliminating red tape (especially for smaller firms), strengthening institutions (in areas like justice systems), fighting poverty directly via the types of Conditional Cash Transfer programs adopted by countries like Mexico and Brazil, improving the quality of primary and secondary education, boosting countries’ effectiveness at developing and absorbing technology and addressing the special needs of historically disadvantaged groups including indigenous peoples and Afro descendant populations across Latin America.
Alternative usage visa-vis foreign policy
In early 2008, the term “Washington Consensus” was used in a different sense as a metric for analyzing American mainstream media coverage of US. foreign policy generally and Middle East policy specifically. Marda Dunsky writes, “Time and again, with exceedingly rare exceptions, the media repeat without question, and fail to challenge the “Washington consensus”, the official mind-set of US governments on Middle East peacemaking over time.”
According to syndicated columnist William Pfaff, Beltway centrism in American mainstream media coverage of foreign affairs is the rule rather than the exception: “Coverage of international affairs in the US is almost entirely Washington-driven. That is, the questions asked about foreign affairs are Washington’s questions, framed in terms of domestic politics and established policy positions. This invites uninformative answers and discourages unwanted or unpleasant views.” Like the economic discussion above, the foreign policy usage of the term has less to do with what is included than with what is missing.
A similar view, though by a different name, is taken by Fairness & Accuracy in Reporting (FAIR), a progressive media criticism organization. They note “Official Agendas” as one of nine ‘issue areas’, they view as causing ‘What’s Wrong With the News?” They note: “Despite the claims that the press has an adversarial relationship with the government, in truth US. media generally follow Washington’s official line. This is particularly obvious in wartime and in foreign policy coverage, but even with domestic controversies, the spectrum of debate usually falls in the relatively narrow range between the leadership of the Democratic and Republican parties.”