Why have the principles of the Washington consensus failed to deliver their desired development goals in developing countries despite their theoretical appeal?

Charlotte Bath 282202 GGH3151

Gore (2000) discusses how developing a country is an “international practice” entailing

“The mobilisation and allocation of resources, and the design of institutions to transform national economies and societies, in an orderly way from a status of...less developed to one of being more developed” (Gore)

This practice often requires the aid of governments in wealthy countries’, non-governmental organisations and “international intergovernmental organisations” such as the United Nations (UN) and World Bank, to stimulate and promote economic growth and development.

This essay examines the basis for development in developing countries since the 1950s, introducing the ideas of Import Substitution Industries (ISIs) before discussing the ‘paradigm shift’ that led to the introduction of the Washington Consensus in 1989. Additionally, this essay considers, with relation to several case studies, why the Washington Consensus has been “a disaster for developing nations” (Davison, 2003). Finally, brief discussion is raised on what has been done to improve the development prospects for the less developed economies with new approaches and ideas that have been implemented.

Prior to the Washington consensus, development was often focussed within a national framework. The ‘key ingredients’ to successful development were designed in accordance with the processes industrialised countries such as the United States and United Kingdom had followed. Once identified, these processes were implemented into developing country policy with little consideration of the differences in economy, political stability and human capital (Gore, 2000). One favoured scheme was Import Substitution Industrialisation (ISI), a trade and economic policy in which a developing country should attempt to substitute its imports with locally produced substitutes (Wilkipedia, 2005). Such a policy seemed to ‘make sense’ and as Waterbury (1999) described, “…fitted wonderfully with politicians craving for discretion and control”. This was because ISI had three major beliefs in

Active industrial policy to subsidise and orchestrate production of strategic substitutes.
protective barriers to trade (tariffs, trade quotas and quantitative trade restrictions)
monetary policy that keeps domestic currency overvalued

(Wilkipedia, 2005)

This was a widely implemented policy, supported by Waterbury (1999) who remarked, “ISI was to the developing world since world war two, what the Washington Consensus has been in the last decade”. It had remained a dominant feature in many developing economies as it offered the prospect of real growth, national strength and considerable protection against external shocks. However, as with most development strategies, crises were rarely absent and problems with the unsustainable external debt, balance of payment, and high inflation became increasingly evident in many economies. This failure led individuals to seek alternatives to development, accounting for the adoption of the Washington Consensus as a solution.

Thus to this point, the essay has briefly introduced past development policies and regimes, focus of the essay will now turn to the Washington Consensus and the development goals it desired to implement.

The Washington Consensus was coined by John Williamson in 1989 as a way to codify the economic liberalization policies encouraged by International Financial Institutions (IFIs) as part of their strategy of structural reforms (Ocampo, 2005). Originally, the consensus was designed to promote economic growth in Latin America following its financial crisis in the 1980s and is recognised as a list of ten policy actions:

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Fiscal policy discipline-this describes the actions of governments setting the level of public expenditure. Often many countries had amounted large deficits creating balance of payment crises and high inflation that affected the less wealthy in a nation.
Reordering public expenditure priorities towards education, health and infrastructure investment.
Tax reform constructing a system that would combine a broad tax base with moderate marginal tax rates.
Interest rates that are market determined and positive (but moderate) in real terms
Competitive exchange rates.
Trade liberalisation-replacement of quantitative restrictions with low uniform tariffs ...

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Fiscal policy discipline-this describes the actions of governments setting the level of public expenditure. Often many countries had amounted large deficits creating balance of payment crises and high inflation that affected the less wealthy in a nation.
Reordering public expenditure priorities towards education, health and infrastructure investment.
Tax reform constructing a system that would combine a broad tax base with moderate marginal tax rates.
Interest rates that are market determined and positive (but moderate) in real terms
Competitive exchange rates.
Trade liberalisation-replacement of quantitative restrictions with low uniform tariffs
Liberalisation of Inward Foreign Direct Investment
Privatisation of State enterprises.
deregulation-abolition of regulations that impede entry or restrict competition
Legal security for property rights

(Davidson, 2003:2)

There are three main ideas underlying these reforms which Williamson (2005) identified as

Macroeconomic discipline-by controlling inflation and reducing fiscal deficits.
Outward orientated investment-opening their economies to the rest of the world through trade and capital account liberalisation
Market economy-promote through privatisation and deregulation.

According to Williamson (2005), the list of reforms emphasised that policy was changing from state orientated development that was inflation based and involved Import Substituting Industrialisation, towards one more “orthodox in OECD (Organization for Economic Cooperation and Development) countries.” Liberalisation had ‘heavy emphasis’ within Williamsons proposal reflecting the reality that Latin American countries had large and inefficient state-owned enterprises and repressive state regulation that would therefore benefit from such proposals.

Williamson developed the consensus from Keynes General Theory (1936) and Bretton woods writings to establish reforms that were founded on “classical economic theory” that supported a “laissez-faire doctrine as necessary to solve all our economic problems” (Gore, 2000). This idea has been eagerly challenged by economists such as Rodrik (2003) and Stiglitz (2002) who exclaimed that the effect of the Washington Consensus policies has “…all too often been to benefit the few at the expense of the many, the well off at the expense of the poor” (2002). Moreover, Davidson (2003) considered the evidence of the last 10-20years and remarked “…attempting to implement the ten reforms of the Washington Consensus has ultimately proven to be a disaster for developing nations”. In recent years, critics perceive the Washington Consensus to have failed in its approach to ‘revolutionise’ development policy. As Santiso (2004) proclaims, the 1990s have been a “disappointing decade of recurrent turbulence and unmet expectations”. Financial crises have led to growing frustration with the neo-liberal market model and its promises of a “trickle down effect”. As this essay will now demonstrate, such an idea is true to an extent when one considers the examples of Latin America countries that have suffered greatly because of implementing these reforms.

The Washington Consensus was primarily implemented in Latin America, an area Williamson perceived as having a “large and inefficient state-owned enterprises” (Williamson, 2005). Latin America became the ‘showcase’ of the Washington Consensus and avidly adopted the principles of economic liberalisation in the mid 1980s (Ocampo, 2005). However, Latin America did not perform as anticipated; a comment supported by John Williamson who admits that the “economic performance of Latin American countries had been disappointing” (Williamson, 2005). Davidson (2005) identified that the main issue many countries had to contend with was that as markets liberalised and governments shrunk, international finance and International Monetary Fund (IMF) loans flowed into the country. Normally, this would stimulate growth and improvement within a nation; however, many countries experience was that the inflow of funds resulted in a large and unmanageable international debt that often could only be met via more loans from the IMF and international banks.

Chile was the first to pioneer in “opening up its economy and aggressively pursuing market-orientated reforms” (Cameron, 2005). Following the example of Chile, many other countries in Latin America started liberalising in the 1990s. Latin American economies had experienced prolonged bouts of hyperinflation and stunted economic growth throughout the ‘lost decade of the 1980s creating an increase in poverty levels. The introduction of “trade liberalisation, privatisation, market deregulation and fiscal reform” (Cameron, 2005) in the 1990s had promised a more competitive climate for the nation and attracted multinational companies and Foreign Direct Investment (FDI) who favoured the open market and low cost of production Latin American countries could offer. Undoubtedly, the agenda delivered some improvements in economic policy such as a reduction in inflation, condensed external debt ratios and some economic growth. Chile has been most successful adopting the consensus and was the first to attract multinational corporations after granting extensive open access to its mining resources. Chile’s success was a result of successful initiation of controls on “capital inflows” which thus helped avoid any balance of payment crises. In 1991, the Unremunerated Reserve Requirements (URRs) were introduced to reserve some of the capital inflows to help avoid currency appreciation. (Pereira and Varela, 2005). The reforms have unfortunately proved largely insufficient as macroeconomic and fiscal discipline do not automatically translate to economic growth as many believed. As Santiso (2004) adds, “market reform itself is not a development strategy”. Other Latin American countries were not so fortunate in their involvement of the Washington Consensus principles.

Argentina was already experiencing great financial difficulties in the late 1980s having borrowed heavily to improve its investment potential. The state became unable to pay the interest on the debt it had and the economy collapsed causing inflation to rise to 200% per month. The consensus appealed to Argentina but was a challenge due to the strong position of the ‘Convertibility law’, (see Pereira and Varela, 2005), which kept the peso pegged to the US dollar at a ‘one to one’ exchange rate, an overvaluation of the currency. Participation in the ten principles of the Washington consensus failed to help as a fixed exchange rate created cheap imports but a high export of capital therefore reducing its economic growth. Unfortunately, Latin America was not a prosperous region and the weak Argentinean economy went into recession due to several factors such as a weak ‘natural’ comparative advantage in agriculture and a lack of fiscal discipline. Similarly, Brazil and Mexico faced economic crises too, which furthermore discouraged investors to ‘trust’ Latin American countries financially affecting the overall economy of the region. The following table illustrates that the GDP per capita growth for the Latin American countries was better in the 1990s than the 1980s when growth was negative.

Source: Pereira and Varela, 2005

The GDP of Latin America did grow at 0.9% annually in the period 1991-2002, which is low compared to 3.32% in the 1970s (Table 1). Additionally, among the seven countries analysed which account for 90% of Latin America and the Caribbean’s GDP, only Chile presented growth. Two decades of market reforms saw 12 middle-income developing countries experience major financial crises between 1994-2002. Latin America has suffered with the ‘Tequila crisis’ in Mexico (1994-5), ‘Samba crisis’ in Brazil (1998-99) and argentines ‘last tango’ since late 2001.

Thus, one can summarise to this point that the Washington consensus agenda was “incomplete”. Ocampo (2005) argues that the fundamental problems of the Washington consensus lie in four areas:

Its narrow view of macroeconomic stability
Disregard for the role policy interventions in the public sector can play in inducing investment and accelerating growth
Hierarchical view of the relation between economic and social policies
Its tendency to forget that it is the citizens who should choose what economic and social institutions they prefer.

(Ocampo, 2005)

The Washington consensus although narrow in approach, had the virtue of being tangible, action orientated, and politicians adopted it because the goals it presented appeared achievable. In the 1990s, there was a widespread expectation that macro-economic discipline was the solution for prosperity and the decade ended with the realisation that “sound macroeconomics is not a goal but a precondition” highlighting that further factors are required for sustainable development.

Hence, there was a notable problem with the policy agenda of the Washington consensus, and reforming countries realised it was too focussed upon economic development and ignoring the importance if social capital and future growth. For example, the elimination of restrictions on foreign investment was good to attract foreign capital however; it was not making the country internationally competitive in the race to attract long-term foreign investment. Opponents to the Washington consensus began to challenge the reforms and highlighted that for long-term development, countries needed to implement factors such as a reliable justice system and a well-educated work force. John Wolfersohn, World Bank President commented, “We cannot adopt a system in which macroeconomic and financial is considered apart from the structural, social and human aspects and vice versa…” (Naim, 1999)

The emergence of the post-Washington Consensus recognised the ‘sharpness’ of the Washington Consensus and acknowledged however that, “…social factors are decisive for success in development” (Fine et al, 2003). The post-Washington consensus, remains “rooted in fiscal and monetary matters” (Davidson, 2003) and in favour of free trade and privatisation. In comparison, it offers a “milder opening of the economy” in response to market requirements allowing the country to have some control. Held (2005) states that economic change needs to “…calibrate the freeing of markets with poverty reduction programmes and…protection of the vulnerable throughout the world”. Moreover, Held recognises that when economic development is unregulated and follows the current guidelines of neo-liberal reform, it will not lead to prosperity, “…economic development needs to be a conceived as a means to an end, not as an end to it all” (2005). Further policies such as the United Nations, Sustainable Human Development Programme (SHD) aim to incorporate these ideas of development as a “means to an end”. This programme offers a different set of values, compared to the ‘traditional’ consensus below, that are more sustainable in approach and would potentially benefit developing economies as they establish the problems from within the nation.

(Source: Gore, 2000)

In conclusion, the Washington consensus has failed to deliver to an extent its desired development goals despite the theoretical nature of its approach. The Washington consensus was seen to be the “panacea to end developing countries”(Gnos and Rochon, 2005), however the last 10-20 years have illustrated that their implementation was disastrous for developing nations (Davidson, 2003). The various financial crises have led to doubts over the benefits of opening economies and liberalisation of already weak markets. Rodrik (2003) declared, “Any list of x policy reforms is bound to disappoint, because it offers an agenda that is insensitive to local context and need”. Unfortunately, from the evidence presented in this essay, one can conclude that the Washington consensus did not consider sufficiently the status of the countries it was applied to. For example each country has varying income inequalities and political statuses that a “one size fits all model” will not fulfil. Policy measures have to be adapted to individual conditions and external environments.

The post-Washington consensus and additional development programmes have highlighted that for economic development to be successful, strong institutions and recognition of the value of social capital are vital. Arguably, Williamson (2002) was correct in admitting that the polices of the consensus were perhaps “too rigid for developing countries”. The problem with the Washington consensus was that it listed what became regarded as “10 commandments, with an implicit promise that countries that did these ten things would grow” (Williamson, 2005). Thus, focus now is on promoting sustainable development that combines both social and economic factors.

References

Casanova, L (2005) “Latin America: economic and business context” International Journal of Human Resource Management 16, 2173-2188

Davidson, P (2003) “What is wrong with the Washington consensus and what should we do about it?” Paper presented at conference

Davidson, P (2005) “A post Keynesian view of the Washington consensus and how to improve it”, Journal of Post Keynesian Economics, 27(2) 207-228

Fine, B., Lapavitsas, C., and Pincus, J (2003) development policy in the twenty first century: Beyond the Post Washington Consensus, Routledge, New York

Gore, C (2000). “The rise and fall of the Washington consensus as a paradigm for developing countries.” World development, 28(5) 789-804

Gnos, C and Rochon, L.P. (2005) “What is next for the Washington consensus? The fifteenth anniversary, 1989-2004. Journal of Post Keynesian Economics, 27(2) 187-193

Held, D. (2005) “Toward a new consensus: Answering the Dangers of Globalisation” Harvard International Review, 27(2) 14-17

Manuel, T. A.(2003) “Africa and the Washington consensus: Finding the right path”, Finance and development.

Naim, M. (1999) [online] “Fads and Fashion in Economic Reforms: Washington Consensus or Washington Confusion?” Foreign Policy Magazine, I [accessed 21 December 2005]

Ocampo J.A.(2005) “Beyond the Waashington Consensus: what do we mean?” Journal of Post Keynesian Economics, 27(2) 293-314

Periera, CL and Varela, C.A. (2005), “The second Washington consensus and Latin America’s quasi-stagnation” Journal of Post Keynesian Economics, 27(2) 231-250

Santiso, C (2004) “The contentious Washington Consensus: reforming the reforms in emerging markets” Review of international Political Economy 11(4) 828-844.

Waterbury, J. (1999) “The long Gestation and brief triumph of Import Substituting Industrialisation. Resources Policy 30(2)

Williamson, J (2005) “The strange history of the Washington consensus”, Journal of Post Keynesian Economics, 27(2) 195-206

Wilkipedia [online] [accessed 12 December 2005]

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CHARLOTTE BATH

282202

MODULE CODE: GGH3151

CHARLOTTE BATH

282202

MODULE CODE: GGH3151