ECONOMIC AFFAIRS: by Colin TeeseNews Weekly
Time to reappraise the Washington Consensus?
, December 22, 2012
Regular readers of News Weekly will be familiar with the term Washington Consensus, even though the term, originally coined in the United States, is seldom used in Australia.
When used here, it has usually been associated with a strict free-market approach to economic management, characterised by the pursuit of small government, lower taxation, deregulation of financial markets, free trade and privatisation. The “consensus” surrounding these policy prescriptions was said to have been shared by the US Treasury, the International Monetary Fund (IMF) and the World Bank.
That the above agencies adopted and promoted something called a Washington Consensus, which they believed was applicable to all Western economies, is incontestable; but the true origins of this approach are to be found elsewhere.
The term Washington Consensus was originally coined in 1989 by an American development economist, John Williamson, and presented to the Institute of International Economics, an economic think-tank based in Washington DC.
Williamson, a senior fellow of the institute, put forward a 10-point plan, which he believed enjoyed consensus support in Washington economic circles. The plan set out the kind of changes which most Latin American economies might need to follow if they wanted to achieve sustainable economic growth.
Williamson’s proposals represented a departure from what previously had been assumed to be the necessary pre-conditions for growth in developing countries. Before Williamson, it was widely held — especially in developing-country economic circles — that such countries needed special arrangements to achieve growth. These included budget-deficit financing, import-replacement policies as a basis for industrialisation, and a resistance to inward foreign investment (which developing countries in those days saw as a new form of colonisation).
Williamson’s purpose was to contest the idea of the need for special arrangements. Economic orthodoxy, to which Williamson generally adhered, decreed that there was only one path to development and it applied to developed and developing countries alike.
So, what exactly were the policy prescriptions that Williamson proposed?
Eight years ago the author defended his original proposals in a 12-page article, “The strange history of the Washington Consensus” (Journal of Post-Keynesian Economics, Vol. 27, No. 2, Winter 2004/05, pages 195-206). In it he claimed that his ideas had been widely misunderstood by being wrongly associated with what he called “neo-liberalism or market fundamentalism”.
In his article (p.196), he summarised his original 10-point plan as follows:
1) Budget deficits small enough to be financed without recourse to “inflation tax” (i.e., bracket creep).
2) Public outlays should serve economic rather than political purposes.
3) A broader tax base with lower marginal rates.
4) Financial liberalisation to achieve market-determined interest rates.
5) Unified and managed exchange rates across Latin America fixed at a level sufficiently competitive to induce a rapid growth in non-traditional exports.
6) Quantitative import restrictions to be phased out and replaced with tariffs, which would be progressively reduced to a uniform low rate in the 10-to-20 per cent range.
7) Abolition of barriers impeding inward foreign direct investment (FDI).
8) Privatisation of state enterprises.
9) Deregulation and removal of impediments to new firms’ ability to compete with established firms.
10) The provision of secure property rights.
These ideas, Williamson maintained, were widely accepted in Washington economic circles — hence the name “Washington Consensus”. Williamson believed that once the idea of separate and different arrangements for developing countries had been put aside, the 10 policies he advocated would thenceforth be regarded as unexceptional and necessary conditions for economic progress in developing countries.
He expressed deep dismay that his Washington Consensus ideas had been wrongly characterised as being synonymous with market fundamentalism. “This I regard as a thoroughly objectionable perversion of the original meaning,” he protested (p.201).
Williamson’s 2004/05 defence of his original Washington Consensus naturally excited academic passions and attracted much critical debate in subsequent issues of the Journal of Post-Keynesian Economics.
The fact that Williamson waited 15 years to mount a defence of his 1989 program aroused suspicion. The taking up and promoting of his ideas by the market fundamentalist groups he mentioned did in fact occur. Some of his critics suggest, not unreasonably, that he was content to have his ideas popularised for a wider purpose when they seemed to be acceptable pretty much throughout the Western world. However, after 2001, when what was understood to be the Washington Consensus program appeared to falter, Williamson sought to distance himself from its failures.
Even so, not all of Williamson’s self-defence can be dismissed as self-serving. Some of his critics have attributed to him ideas he did not advance. Central to his program to help struggling Latin American countries were plans to encourage foreign direct investment, establish and maintain exchange rates that would enable these countries to be internationally competitive, and to privatise large, inefficient government-owned enterprises.
Williamson correctly argued that, as far as government budgets were concerned, it was misguided to believe that a budget deficit policy was sustainable, even if the subsequent government outlays were destined to finance necessary infrastructure. Still less was this so if the outlays were directed towards the financing of projects with a largely political rather than an economic purpose.
His proposals on securing property rights, taken in context, seem reasonable. Presumably, he had in mind the impossibility of encouraging foreign direct investment in the absence of protection of property rights.
On trade liberalisation he wasn’t entirely consistent. His proposal to get rid of quantitative restrictions (e.g., quotas and licences), in favour of tariffs held at levels of between 10 and 20 per cent, was decidedly protectionist. But he condemned the idea of import-replacement policies, presumably on the grounds that the domestically-produced alternative would usually, at least in the beginning, be more expensive. Freer trade, he believed, was the better path to industrialisation.
Many economists of the Williamson variety adhere to this view, but there is little empirical evidence to support it. The early industrial development of Britain, Europe and the US took place behind protectionist barriers.
First comes the establishment of sustainable domestic industries sheltered from import competition. It is only later, when a newly industrialising economy has created domestic industries powerful enough to take on external competition, that the country is prepared to adopt free trade.
Now that we have obtained a clearer understanding of Williamson’s original purposes, it is time to consider how and by whom his Washington Consensus was appropriated. Williamson has put it well enough himself.
By 2000, the idea of the Washington consensus had been misappropriated by the elite economists of the US Treasury, the IMF and the World Bank and redefined according to their views. This group was less concerned with Williamson’s original plan than with advancing an extremely conservative economic agenda.
Williamson pointed out eight years ago that of his 10 points only privatisation was common to the ideas of the group.
Moreover, two key elements of the group’s policies — floating exchange rates and financial deregulation — Williamson emphatically does not support, and indeed regards as positively harmful.
The group was also indifferent to widening income disparities, which Williamson believed to be an important problem that must be addressed. The IMF and the World Bank later came round to Williamson’s views on income disparities, but the US Treasury still does not believe it is a problem.
The reason the three agencies embraced the conservative economic agenda is perhaps connected with the confused aftermath of the 1944 Bretton Woods agreement which, until its collapse in 1971, had provided an international financial framework in which the West was more or less held together under a sort of US-devised umbrella. That shorthand description is hopelessly oversimplified. The subject is both complex and controversial, and justifies a more detailed article in its own right.
Against this background, the question remains: how did Williamson’s Washington Consensus ideas for Latin America come to drift so far off course? The author himself has conceded that the idea of any consensus had evaporated by 2000. That certainly is true; but the real question is what kind of a consensus had he identified back in 1989?
At best, it would seem to have been a coming together of minds of mainstream Washington economists — committed free-market believers coming up with what they judged was needed in “Latin America” — in other words, a set of economic principles not dissimilar to those they believed had propelled the US into becoming the world’s foremost economic power.
That there was much wrong with Latin America’s economic (and political) management at the time is beyond question. Whether or not a Washington-conceived set of principles was likely to be acceptable, or would work, is something else.
Four issues are important to consider:
First, Latin American countries, like many other developing countries at the time, wanted the West to provide direct financial aid and technology transfers, all without strings attached. Whatever were the merits of such an approach, it was never the way the US, or indeed other Western countries, could or would have responded.
Second, whatever Williamson’s “consensus” might have believed, any model for the region’s development originating in the US was unlikely to be well received. Too many unhappy experiences of earlier US interventions in Latin America had undermined the possibilities for trust, whatever might have been the merits of the ideas.
Third, Williamson’s perceived consensus might have been too narrowly focused. Emerging developing countries need more than a catalogue of economic “reforms”. Perhaps even more important is the need for what might be called “appropriate institutions” — that is, an effective management structure to oversee development. This must be home-grown, and takes time to evolve.
Fourth, is the fatal commitment to the simplistic economic notion of “one size fits all”. Is there really an entity called “Latin America”? Or Asia? Or even Europe? Whatever features a group of neighbouring economies might have in common, cultural differences must be accommodated in any set of economic proposals.
What’s happening in the European Union right now makes this abundantly clear.
Williamson almost certainly did not deserve much of the criticism heaped on him by certain colleagues. Perhaps, however, his critics would have been more kindly disposed had he been able to broaden his search for consensus beyond mere economics.
Colin Teese is a former deputy secretary of the Department of Trade.