Economic Reform For Whom?
Jomo K. S. (United Nations [Assistant Secretary General for Economic Development], Malaysia)
© Copyright: Jomo K. S. 2005
The Washington Consensus emerged in the 1980s after the end of the Golden Age decades of post-war capitalism (Williamson 2004). From the mid-1970s, the North Atlantic economies seemed to be afflicted by a phenomenon not anticipated by Keynesian economics, by what was called ‘stagflation’ – economic slowdown on the one hand and high inflation on the other. This crisis of Keynesianism resulted not only in the rejection of what Joan Robinson called ‘bastard Keynesianism’ on the western side of the Atlantic, but also the jettisoning of development economics. This was worsened by the debt crises that affected Latin America and Africa in particular, as well as changes in the political landscape and the resurgence of free market conservative ideologies, quite unlike the paternalistic conservatism of the Golden Age associated with the ‘social market’ economy or the welfare state.
The 1980s’ turn to economic liberalization generally undermined state capacities by reducing public sector economic activities and reducing fiscal capacities. In the realm of ideas, this had been preceded by what John Toye (1987) called the ‘counter revolution’ against development economics. The early 1980s’ sovereign debt crises led to stabilization programmes under the auspices of the IMF and structural adjustment programmes (SAPs) managed by the World Bank. Together, they quickly obliterated and reversed the McNamara-Chenery heritage at the World Bank.
This was also reflected in academia, principally in the economics curricula of US graduate schools. One can see this, for example, in the shift from development economics to open macroeconomics, the renewed emphasis on international trade theory, the shift to rational expectations in economics and to rational choice in the other social sciences, as well as the emphasis on supply side economics versus the previous Keynesian emphasis on demand management. The result, inaugurated with more than a little help from supportive political authorities, was what has come to be called the Washington Consensus, the supposed ‘policy consensus’ of the US leadership and the Bretton Woods institutions, both based in the US capital, Washington, DC. To a great extent, it was based on an ostensibly ‘free market’ critique of Keynesian and development economics.
There has since been growing recognition of serious problems with the original ideas associated with the Washington Consensus with some revisions as well as the arguably premature declaration in 1998 of a ‘post-Washington Consensus’ by the World Bank’s then Senior Vice President and Chief Economist, the Nobel laureate Joseph Stiglitz (2004). However, critical scrutiny of recent fads in development economics suggest little more than a ‘false dawn’, especially when compared to the discourse preceding the relatively recent rise of the Washington Consensus, despite all its problems and limitations (Jomo & Fine 2006). But the laws of inertia in ideas are often determined by political conditions. And as far as its ideas and policy influence are concerned, the Washington Consensus has received a new boost with subsequent political developments, including the election of President George W. Bush in 2000.
The most important challenge to the Consensus is its failure to deliver on its promise of higher economic growth over the last quarter century. Instead, we have seen significantly lower growth in the world as a whole, not only affecting the developing world, but also the advanced economies. We have seen much lower growth, almost two per cent lower in the last three decades, compared to the 1950s and 1960s (Weisbrot, Naiman and Kim 2000). Meanwhile, high growth has occurred precisely where the policy prescriptions of the Washington Consensus have been resisted. The highest growth region, until the 1997-98 crisis, was East Asia, where most economies hardly qualifies as star pupils of the Washington Consensus.
A growing number of challenges have posed major problems for mainstream economics. There is no time here to go into all this, but the challenges posed by strategic trade theory, for instance, has important implications for development economics. The importance of market imperfections and market failure – due to information asymmetries, for example – is increasingly recognized, especially since the 2001 Nobel Laureates for information economics. Also very important for mainstream economics has been the challenge from post-Keynesian economics and other sources. The Austrian school challenge from the right, with the renewed interest in evolutionary economics, has also raised very important issues.
Another important recent interest has been in ‘institutional economics’, which has encouraged some economists to embrace more multi-disciplinary and inter-disciplinary work. Although development economics has always been more open than mainstream economics, the renewed interest in institutions is probably welcome despite its often opportunistic and convenient eclecticism as well as vacuous black-box socio-cultural explanations that have become the vogue in recent years. The renewed interest in political economy (especially rent seeking), law, property rights, contracts and social capital have all been similarly promising, but largely disappointing, if not misleading. The joke about the new development economics is that when something is difficult to explain, one can always try ‘governance’ or ‘social capital’. Often, they have become a sort of factor x to conveniently ‘explain’ what cannot be explained by other methods.
Another important global development has been growing inequality, despite what some commentators claim, attributed by most observers to the policy and institutional changes associated with the kind of economic liberalization favoured by the Washington Consensus. Branko Milanovic has decomposed global household income distribution to show that although intra-country inequalities can be very high, most world inequality is explained by international, rather than intra-national inequality, although the latter has been growing and is often high. Instead of ‘convergence big time’, we have ‘divergence big time’, dating back to the early 19th century (see Maddison; Bourguignon and Morrison), even though this was temporarily reversed during the post-war Golden Age. There is a large body of literature that suggests that economic liberalization and some key aspects of the multi-faceted phenomenon of globalization have significantly increased income inequality at both national and international levels (e.g. see Jomo 2006). There is also much evidence – e.g. from diverse sources ranging from Forbes magazine to the UNDP Human Development Report – that wealth inequality is growing even faster than income inequality.
If the greatest sources of global inequality have been international, rather than national, we have to look at the consequences of international economic liberalization -- or globalization -- much more carefully and critically. In this regard, it is relevant to look at five issues: intellectual trade, investment, finance, intellectual property rights and the new international economic governance.
The case for trade liberalization has been undermined by growing evidence of widespread ‘jobless growth’, the ambiguous evidence of the employment effects of trade liberalization and the misleading claims of earlier advocates of trade liberalization (Rodriguez and Rodrik). Even Paul Samuelson, the doyen of mainstream international trade theory, has acknowledged what most critics, especially from the South, have long argued, i.e. that trade liberalization does not necessarily ensure welfare gains for all, even in the medium term, but that outcomes instead depend very much on ‘initial conditions’ (resource endowments), the short and long term dynamic consequences of the new international economic specialization as well as economic capacities to take advantage of the new opportunities thus offered.
Many trade issues first raised in the 1950s and 1960s are still very much with us, like the persistent decline of primary commodity prices compared to manufactured goods first identified by Raul Prebisch and Hans Singer over half a century ago. Consider how coffee prices in East Africa and Latin America have dropped dramatically with the advent of Vietnamese coffee production. The list of examples is long. Secondly, W. Arthur Lewis also pointed out many decades ago that the terms of trade for tropical primary commodities have also declined against temperate primary commodities, e.g. cotton versus wool.
Thirdly, and increasingly important in recent decades, generic manufactured products have been experiencing worsening terms of trade, as in East Asia. This appears linked to the declining terms of trade for ‘generic manufactures’ against products with strong intellectual property rights, i.e. officially protected monopolies in an age of ostensible liberalization. For example, the successful entry of low-cost East Asian manufacturers into various electronic component industries not protected by strong intellectual property rights often led to intense cut-throat competition. This has driven prices down as productivity gains have translated into vicious ‘beggar thy neighbour’ cycles. High unemployment and underemployment in China have also served to keep industrial wages down, enabling higher labour productivity – thanks to high investment rates – to lower output costs and even consumer prices.
The conclusion of the Uruguay Round of trade negotiations saw the World Trade Organization (WTO) replace the General Agreement on Tariffs and Trade (GATT) with considerably enhanced powers and a significantly broadened scope of ostensibly trade related matters. Perhaps most importantly, membership of the WTO involves a ‘single undertaking’ requiring compliance with all WTO agreements unlike the previous option under GATT of signing up on an agreement by agreement basis. The WTO has also created and strengthened processes and mechanisms for dispute settlement, that have tended to favour corporate interests and rich country governments who can better afford the legal and lobbying resources to pursue and advance their interests.
The WTO trade agenda has broadened from GATT’s focus on manufactures to include services while giving renewed attention to agriculture. Undoubtedly, many developing countries with strong agricultural productive capacities will benefit from less protected markets in the North for their exports. Historically, however, there has been a great deal of hypocrisy – and self-interest – in the rhetoric and practice of trade liberalization. For example, many critics note that the European declared trade liberalization objective of ‘everything but arms’ has, in practice, involved ‘everything but farms’. In any case, the gains from agricultural trade liberalization will mainly benefit a few successful agriculture exporting countries, including those in North America and Australasia, rather than, say, Africa where many gain from subsidized European food prices.
Meanwhile, liberalization of services has mainly involved financial services, rather than construction or maritime services where developing countries are better able to compete. Although the proposed Trade Related Investment Measures (TRIMs) were not fully adopted, the OECD’s MAI (Multilateral Agreement on Investment) was aborted and investment liberalization is no longer on the Doha Round agenda, preparations for an MIA (Multilateral Investment Agreement) with similar objectives are said by some to be continuing, although they are not imminent. Meanwhile, the Agreement on Trade Related Intellectual Property Rights (TRIPS) has given transnational corporations greater monopoly powers -- not provided by WIPO, the World Intellectual Property Organization.
On the other hand, regional free trade arrangements as well as bilateral free trade agreements – both, often misleadingly referred to collectively as FTAs -- may inadvertently serve to slow down multilateral trade liberalization although they are often rationalized as building blocks for the latter, or as intended to put pressure to accelerate progress in that direction.
UNCTAD’s World Investment Report of 1999 showed that more than 80 per cent of foreign direct investment (FDI) in the world in the 1990s consisted of mergers and acquisitions (M&As). And as far as the South is concerned, most of these have been acquisitions, rather than mergers. Hence, most FDI is not ‘green-field’ investment that creates new productive capacity. And while ‘green-field’ FDI may increase economic capacity, it may also pre-empt the development of indigenous capacities and capabilities, besides draining away much of the economic surplus needed to sustain growth in the medium and long term. Recent pressures for investment deregulation, ostensibly to attract more FDI, have in fact resulted in fewer gains for host economies from incoming FDI owing to the more generous terms and conditions offered. Meanwhile, there has been a decline of global FDI, especially to the South, since the mid-1990s.
International Financial Liberalization
Greater capital flows, due to financial liberalization, have not resulted in net inflows of funds from the capital-rich to the capital-poor. The opposite has, in fact, been the case. The cost of capital has not fallen, while the volatility of the international financial system has grown, due to -- rather than despite -- financial deepening. Meanwhile, the frequency and severity of currency and financial crises have increased. Although some new derivatives have reduced some old sources of volatility (due to exchange or interest rate fluctuations, for example), new sources of volatility have been created by these very same instruments, exacerbated by greater ‘financialization’ reflected, for example, by the growth of hedge funds.
International financial liberalization has made finance capital much more influential and dominant, exerting severe deflationary pressures on macroeconomic policy throughout the world, which has slowed growth. Financial liberalization has also undermined financial policies, institutions and instruments to pro-actively promote growth of desired firms and industries.
Strengthened intellectual property rights have reduced technology transfer, and raised the costs of technological acquisition, and consequently, productivity, growth and competitiveness improvements. Revenue from IPRs is now believed to be the greatest single source of foreign exchange earnings for the USA. Recent studies suggest that this is not just inequitable, but also inefficient. Publicly funded pharmaceutical research in the US, for example, would be less costly, as well as more equitable and efficient than existing arrangements (Baker & Weisbrot, 2003). Of course, stronger assertion of intellectual property rights is a recent phenomenon, dating from the mid-1980s, and analytically contradicts economic liberalism. IPRs confer exclusive monopoly rights and associated incomes to their owners, thus strengthening the monopoly powers of powerful transnational corporations.
International economic governance issues have become more important with globalization and international economic integraton. As noted above, the Uruguay Round transformed the WTO into a major agency to promote the liberalization of trade as well as other economic transactions while strengthening regulation to strengthen and enhance transnational corporate interests.
Meanwhile, reform of the international financial system has been difficult, but nonetheless remains urgent. There are no longer any serious efforts to address the international financial architecture after the concerns of the late 1990s following the Asian and Russian financial crises. It took 15 years and a world war before there was reform in 1944 after the Crash of 1929. The IMF and the World Bank were thus created at Bretton Woods to address fundamental problems after that systemic crisis.
In 1971, the Bretton Woods system was unilaterally destroyed by President Nixon, but there has been no systemic reform since despite the growing frequency of currency and financial crises in recent years. With the end of the Bretton Woods system, the IMF has created new roles – and rules – for itself, which need to be critically examined. Unlike the UN Security Council, where five countries have veto powers, only the US has veto power in the IMF. In the Bretton Woods institutions, voting rights favour rich country governments in an archaic system inherited from the end of the Second World War.
The IMF is widely perceived to advocate different policies for large developed economies in contrast to emerging markets and developing countries. The Wall Street Journal periodically condemns the Fund for urging the US and Europe to adopt counter-cyclical policies to stimulate their economies, but the Fund rarely urges developing countries to adopt similar counter-cyclical policies. Instead, its macroeconomic and other policy conditionalities and recommendations tend to have pro-cyclical and hence contractionary consequences.
Many observers (e.g. Stiglitz 2002) have also noted that the IMF has made serious policy errors in recent years that have undoubtedly reduced cumulative economic growth and welfare for hundreds of millions of people. In Russia and Brazil in 1998, overvalued exchange rates -- that ultimately collapsed -- caused serious economic damage. Shock treatment and ill-considered transition policies in the economies of the former Soviet Union have, over the last decade and a half, contributed to one of the worst economic disasters in the history of the world, with Russia losing more than half its national income.
The Fund has failed to help devise more effective crisis avoidance safeguards, and IMF involvement has often exacerbated, rather than ameliorated crises when they have occurred. Besides its poor record of crisis aversion and crisis management, it has not significantly enhanced international liquidity to facilitate coordinated reflationary measures to reverse the generally deflationary macroeconomic policies it has encouraged since the 1980s, let alone relieve economic stagnation, poverty and unemployment. Even the IMF Managing Director has been forced to acknowledge East Asian alienation and the need to re-invent the Fund to stay relevant.
William Easterly (2000), then a senior World Bank researcher, has noted that ‘The poor in developing countries are often better off when their governments ignore the policy advice of the International Monetary Fund and World Bank’. IMF and World Bank policymakers claim that their reforms often require necessary short-term pain for the sake of long-term gain. According to him, during times of economic growth, the poor did not gain as much in countries in which the IMF lent money as they did in places with no programs, although they were not hurt as badly in recessions. Meanwhile, China, India and other countries in East Asia that have not followed IMF economic programs and prescriptions have seen more of their people lifted out of poverty in times of economic growth than have nations that take the advice of the Washington-based lenders.
Hence, the Washington Consensus cannot point to any region in the world as having succeeded by adopting the policies that they promote or require in borrowing countries. Understandably, they are reluctant to claim credit for China, which maintains a non-convertible currency, state control over its banking system, and otherwise contradict standard Washington Consensus prescriptions. If globalization and other policies promoted by the Washington Consensus have not led to increased growth, it becomes extremely difficult to defend these policies. The costs of these changes—the destruction of industries, unemployment and lower incomes, besides the harsh ‘austerity’ medicine often demanded by these institutions and by international financial markets—become burdens to society and setbacks to economic development without any compensating benefits.
Meanwhile, domestic financial institutions and policies -- so crucial to earlier developmental efforts (Gerschenkeron 1962) -- have been reduced, if not undermined by financial liberalization. Yet, recent IMF research now concedes that international financial liberalization has not contributed to growth while increasing monetary and financial instability. Yet, IMF operations in most countries do not seem to have recognized the policy implications of its own research.
Lower tax revenues and increasing insistence on balanced budgets or fiscal surpluses have also generally constrained government spending, especially what is deemed social expenditure, with some deflationary consequences. Privatization in many countries temporarily increased government revenues, enabling governments to temporarily balance budgets or have surpluses on the basis of one-off sales incomes. Such budgetary balances are clearly unsustainable, but have succeeded in, at least temporarily, obscuring the imminent fiscal crises such policies may lead to.
In the meantime, structural adjustment programs (SAPs) and now poverty reduction strategies (PRSs) have been used to promote economic liberalization, with adverse consequences for the developing world. Meanwhile, developing countries are much more divided today because much of the burden of the HIPC initiative is actually borne by middle-income borrowing countries, rather than only by the rich creditor countries – as is widely believed.
Of course, the ostensible current focus on poverty reduction is better than the earlier emphasis on stabilization, adjustment and liberalization, but much of the recent discussion of poverty reduction is palliative, rather than developmental in nature, focussing on welfare and distribution without creating conditions for sustainable economic progress. On the other hand, there is widespread suspicion that including poverty on the economic development reform agenda has basically served as sugar-coating on the Bretton Woods institutions’ economic liberalization agenda despite their by now well known in-equitable and contractionary consequences.
The failure of the Washington Consensus to rise to the challenge of human development, especially in the South, requires us to go well beyond its research, analytical and policy agenda. Instead of just adding poverty, or institutions, or governance, or social capital, or culture, or whatever the new policy ‘flavour of the month’ may be, commitment to rigorous economic analysis as well as egalitarian, balanced and sustainable development requires not only critical analysis of Washington Consensus analyses and policies as well as their consequences, but also of the alternatives currently on offer in order to develop feasible and viable development alternatives appropriate and equal to the challenges at hand.
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Jomo K. S. and Ben Fine [eds] (2006). The New Development Economics. Zed Books, London.
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Stiglitz, J. E. (2005). ‘The “Post-Washington Consensus” Consensus’. Processed, Initiative for Policy Dialogue, Columbia University, New York.
Weisbrot, Mark, Robert Naiman, and Joyce Kim (2000). ‘The Emperor Has No Growth: Declining Economic Growth Rates in the Era of Globalization’. Processed, Center for Economic and Policy Research, Washington DC.
Weisbrot, Mark, Dean Baker and David Rosnick (2005). ‘The Scorecard on Development: 25 Years of Diminished Progress’. Processed, September, Center for Economic and Policy Research, Washington DC.
Williamson, John (2004). ‘A Short History of the Washington Consensus’. Paper presented at Foundation DIDOB conference on ‘From the Washington Consensus towards a new global governance’, Barcelona, September.