Washington consensus – definition and criticism

By Tejvan Pettinger on April 25, 2013 in economics

The Washington Consensus refers to a set of broadly free market economic ideas, supported by prominent economists and international organisations, such as the IMF, the World Bank, the EU and the US.

Essentially, the Washington consensus advocates, free trade, floating exchange rates, free markets and macroeconomic stability.

The ten principles originally stated by John Williamson in 1989, includes ten sets of relatively specific policy recommendations.

  1. Low government borrowing. 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, pro-poor 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;
  1. Privatization of state enterprises;
  2. 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;
  3. Legal security for property rights.

The Washington consensus was important for determining policy towards economic development in Latin America, South East Asia and other countries. Some implications of the Washington consensus.

Implications of Washington Consensus

  1. Support of free trade through WTO and NAFTA – North Atlantic Free Trade association reduce tariff barriers.
  1. IMF bailouts tended to involve free market reforms as a condition of receiving money.
  2. Belief in free trade suggests countries, should specialise in goods / services where they have a comparative advantage. This may mean developing economies need to stick with producing primary products.

Criticisms / Breakdown of the Washington Consensus

1. Strategic trade theory. Some economists argue that free trade is not always in the best interest of developing economies. A strict adoption of free trade and comparative advantage can leave developing economies producing low income growth and volatile priced primary products. If countries promoted new industries, it may require both selective tariffs on cheap imports and also government subsidies. For example, the Brazilian government’s support and development of Embraer, helped Brazil become successful in airline manufacturing.

2. Low government borrowing is not always appropriate. Implementing fiscal rules can cause unnecessary economic hardship, if the government cuts spending at inappropriate timing. For example, fiscal consolidation during the great recession has caused low growth rates, and a failure to reduce debt to GDP ratios. If governments are pressured to cut spending it can also cause welfare support programmes to be hit, increasing poverty. However, in the long term, most economists would suggest it is prudent to reduce structural borrowing to manageable levels.

3. The Chinese approach. An interesting development in recent years is that Chinese firms have invested substantial sums in developing economies, such as Africa and Latin America. An FT report, suggests China has lent $110 bn to developing countries in past two years – more than the World Bank. The interesting thing about the Chinese approach is that it involves substantial investment ininfrastructure and public sector investment – showing that for economic development, an interventionist approach can have a bigger return than leaving it to free markets.

4. Problems of privatisation. Privatisation has the capacity to increase efficiency and improve the quality of the product / service. However, for key public sector industries, privatisation may mean companies ignore wider social objectives. For example, in the 1990s, under World Bank pressure, Boliviaprivatisedits water industry. But, this led to water supplies being cut off from the poorest members of society. (politics of water in Bolivia at the Nation)

5. Mis-interpretation. The second point about redirecting of public spending towards public sector initiatives like primary education, primary health care and infrastructure investment, has often been ignored. Instead the ‘Washington Consensus’ has come to refer to more market oriented policies, which have focused on less government intervention.

6. The macro-economic crisis of Latin America in 1980s and South East Asian crisis in 1990s, made this free market policies unpopular in the countries where they were implemented. (see: Criticisms of IMF)

7. Credit crisis and instability of free markets. The credit crisis beginning in 2007 has illustrated the potential for free markets to create instability and high unemployment. Financial deregulation has created potential for financial instability.

In defence of the Washington consensus

  • The 10 principles of the Washington consensus all have considerable economic validity.Broadeningthe tax base, investment in education, sustainable government borrowing, flexible exchange rates e.t.c can all help improve economicwelfare Under certain situations, privatisation and increased competition can have potential benefits. Most economists would support the notion that free trade has potential benefits.
  • It’s always easy to criticise when things go wrong. When South East Asian economies were in great difficulties in the 1990s, it is likely that any policies would be unpopular. When you have a crisis there tends to be no easy way out.
  • The problems of the EU are related to difficulties of managing a single currency. A return to competitive exchange rates would help the crisis to be overcome more easily.
  • The problem with any broad set of economic principles is that it always depends how and when they are implemented. For example, generally free trade is good. It’s generally desirable to have lower tariffs and encourage international trade. However, that doesn’t necessarily mean there isn’t room fortargetedeconomic diversification; some developing economies may benefit from limited trade protectionism to develop new industries. But, even this depends on how it is implemented. If African countries, tried to use tariffs to develop a motor industry, it would probably lead to government failure because the infrastructure isn’t there to support a new motor industry. However, if there was some support to develop primary product processing within the country, it is more likely to be successful. With privatisation it depends what you privatise. In the UK, the privatisation of BT was relatively uncontroversial, but the privatisation of British rail was much more controversial. The difference here is that railways are a natural monopoly and have social benefits.
  • An important point is that an economic policy may have sound justification, but it might not be universally applicable, e.g. free trade. Free trade can tend to give greater benefit to developed economies than developing. But, at the same time, developing countries would benefit if the developed world (EU and US) actually cut agricultural tariffs.

Conclusion

The Washington consensus has diverged somewhat from the original intention of John Williamson. Despite the failings of the free market, there is still merit in considering each of the 10 principles. However, there needs to be greater discrimination and less blanket implementation. The privatisation of state owned car industry may be good, but water supplies may not. Perhaps the most interesting development is the rise of the Chinese and Indian economies. In particular, Chinese investment is playing a considerable role in enabling economic development within developing economies. The Washington consensus is partly tied to the strength of the US economy. But, the US economy is likely to decline in relative terms. Perhaps in a few decades we will be talking about the ‘Chinese consensus’ – whatever that may turn out to be.