Washington Consensus
In 1990 the World Bank Economist John Williamson’s wrote the "Washington Consensus" in response to developing policy ideas on trade, monetary policy and liberalization policy reforms for Latin America economic policy makers in the 1980's (Williamson, 2004 ; Birdsall, 2010). The Consensus is considered by World Bank office of the Chief Economist report in 2010 as a “damaged brand” (Birdsall, 2010). The 2010 report provides a post-mortem analysis of the development history leading to its formation, and review the successes and failures. A similar post-mortem review was also provided by Williamson in 2004 and the two authors arrive at similar conclusions (Williamson, 2004). Birdsall’s analysis is both a critique of liberalization reforms and the Consensus. She is both apologetic and critical of the Consensus and uniformly critical of liberalization. She and Williamson both delineate the boundaries between liberalization ideological free-market reforms and the Consensus, which is a mostly liberalized model with some hybrid elements from the welfare state model.
In this section
1980-1990, Latin America’s lost decade
According to Birdsall and Williamson, the Consensus was as much a consensus among policy makers and economists in Latin America (specifically the United Nations Economic Commission for Latin America ECLAC) as it was a reflection of popular free-market ideologies and rational-expectations neoclassical macroeconomic theory that was “in the air” (Birdsall, 2010) in the late 1980’s in Washington-based organizations - IMF, World Bank. According to Birdsall the priority in Latin America was to recover macroeconomic stability - inflation, currency from the previous period and then to move on to general economic goals of raising incomes, reducing poverty, lower unemployment (Birdsall, 2010). Co-current with the stagflation crisis in the United States Latin America was also facing problems of runaway inflation, high public debt and several currency crises (Birdsall, 2010) and the ripple effects of the Volcker shock also followed with an economic slump in Latin America - the “Lost decade” of 1980-1990. While generally the region experienced modest GDP growth, the perception was that it could have been higher as illustrated in Figure D.6 it mostly tracked with the US general growth and slower than the 7 Asian Tigers (South Korea, Singapore, Hong Kong, Thailand, Indonesia, Malaysia and Taiwan). The currency destabilization and debt crisis of the early 1980’s in particular the Mexican, Argentine peso, with regional inflation averaging 150%. Motivated to recover fiscal stability, the states cut spending and saw unemployment spikes up to 15% in some countries (Birdsall, 2010).
Rise and fall of import substitution
According to Birdsall, prior to 1980 the dominant economic strategy popular among the ECLAC was “inward orientation” with the sequential logic of first building a manufacturing base by “import substitution” to replace those finished goods that are currently imported with domestic alternatives. That manufacturing base then would serve a growing domestic market which would then provide a stable demand from a domestic middle class base (Birdsall, 2010). According to Birdsall, the import substitution model traces its origins from the Prebisch-Singer hypothesis (Prebisch, 1950) which asserted that primary commodities (agriculture, mining) exporters in the long run would be at a disadvantaged terms of trade vs manufactured goods exporters because of the relatively lower income elasticity and price elasticity of demand of essential staples compared to manufactured goods (Prebisch, 1950). The theory was one of several components of an alternative economic ideology of the relationship between Latin America and the advanced economies - “dependency theory” (Birdsall, 2010) which included themes of inward orientation and greater independence.
While the import substitution strategy had some success, and the economies did grow during the period Birdsall cites several concerns among the economists of the 6x “dark sides” (Birdsall, 2010) of import substitution - non-competitive public institutions, rent seeking behavior from distorted market prices, corruption, balance of trade shortfalls, external debt, and ultimately inflation (Birdsall, 2010). In Birdsall’s 2010 critique however she is careful to clarify that the import orientation and strong role of government leadership in “igniting” development were two independent policy strategy choices and not mutually exclusive (Birdsall, 2010). She reported that the sentiment by ECLAC from prior post-war experience was pessimistic that markets would develop on their own in the absence of state intervention to ignite development (Birdsall, 2010). By the beginning of 1980 however, the consensus in Latin America began to shift and open to reforms from at least 5 contributing factors - local currency and debt crisis, skepticism of the dark sides of import substitution, rising popularity of rational expectations neoclassical macroeconomics, success of the Asian Tigers outward-orientation model and general free-market ideology that was “in the air” in the 1980’s.
Emerging consensus
By the end of the 1980’s the economists and policy makers were ready to try something new. The Consensus emerged from three economic strategy goals - macroeconomic stability, export oriented growth and general market oriented reform (Birdsall, 2010).
According to Birdsall and Williamson, while the 10 commandments included key pushes for free-market reforms in areas of interest rate moderation, horizontal tax equity, foreign direct investments capital flows, privatization of state industries and silence on inequality, it was not equivalent to the full aspirations of the free-market liberalization ideology of the Economic Freedom Index (Birdsall, 2010 ; Williamson, 2004). The Consensus instead was a hybrid blend of mostly free-market liberalization with a few policy features of the welfare state model and import substitution. Table D.1 summarizes the areas of contrast between the Washington Consensus and the full free-market liberalization aspirations of the Economic Freedom Index that were “in the air” in the early 1980’s. In policy areas of public spending, deficits and the role of government regulation the Consensus was more moderated from the purist ideological interpretation presented in Table D.2 and these moderated shifts are also reflected in the latest Economic Freedom Index report by the Heritage Foundation (Miller, 2020).
Policy | Ideological purist | Washington Consensus |
Size of government | Reduce and scale back | Re-orientation towards neglected fields with high economic returns - primary health and education, infrastructure |
Deficits | Minimal | Small enough to finance public investments without the inflation tax |
Regulation | Remove anything that impedes economic freedom | Ensure that they are justified on basis such as safety, environmental protection and financial risk supervision |
Table D.2 : Contrasts of common purist interpretations vs actual policy guide from the Washington Consensus (Williamson, 2004) and the most recent version of the Economic Freedom Index (Miller, 2020)
Lackluster results : The great experiment
Once the consensus had formed, the reforms were rolled out expediently starting with macroeconomic stabilization and then trade and capital market liberalization. The results were uneven with some countries performing better than others. According to Birsdall, the reforms that had adhered closest to the Consensus and most consistent and extensive were in Chile with one example provided of the privatization of the publicly administered pension (social security) program from a pay-as-you-go to a privately administered individual account system (Birdsall, 2010). While results were uneven, inflation subsided and reduced steadily from 1990 to 2000, deficits were reduced and external public debt was contained to <60% of GDP (Birdsall, 2010). Tariffs were reduced from 50% in 1980 to 33% by 1990 and the Consensus target 10% by 2000. Correspondingly foreign direct investment (FDI) flows increased.
During the same period from 1990 to 2000 while GDP did grow by a cumulative 12% during the period, with the exception of Chile the results were not much different than in the prior years with growth mostly keeping pace with the US and slower than the Asian Tigers. More disappointing was that while GDP grew, there was little progress on poverty (% living on <$4/day) and inequality. Chile, however did observe a drop in poverty from 38% to 20% but inequality gini index remained around 55 (Birdsall). Despite the lackluster outcomes, the influence of the Washington Consensus spread beyond Latin America.
Global influence
The influence of the liberalization agenda is reflected in the prevalence of countries which adopted the liberalization reforms from the 1970’s to 2008 and continue to present. From 1995 to 2020 the global average Economic Freedom Index increased from 57.6 to 61.6 where a score of 60-70 is considered “Moderately Free” and 70-80 is considered “Mostly Free” and 80-100 as “Free” (6 countries : Singapore, Hong Kong, New Zealand, Australia, Switzerland and Ireland). As of 2019 124 countries are increasing their score compared to only 50 which are decreasing (Miller, 2020). Evidence of the popularity of the policies promoted by liberalization can be seen in Figure D.7 and D.8 of the broad reduction in corporate income taxes and real government expenditures as % of GDP. As of 2019 the average corporate tax rate is 23.9%, government tax burden 21.9%, and spending 32.9% and trade-weighted tariffs is close to 6% (Miller, 2020). The popularity of the ideology could be due to a combination of intrinsic appeal features and timing - contextual circumstances in the 1970’s and 1980’s.
Appeal
The appeal of liberalization could be from its association of economic freedom with the psychological drive for personal autonomy, ideological consistency and the empirical evidence validating the assertions and statistical relationships between the policy measures and aggregate national metrics of material well being and material standards of living (Miller, 2020). The higher cognitive burden of different sets of rules for national scale political economies and interactions among individual levels may be less appealing to the broad public. Aside from the weight of evidence, some may find it difficult - consciously or subconsciously - to hold the belief that it is bad for an individual to carry outstanding debt year after year but it is OK for a government to do the same thing. Ideological consistency is a theme of liberalization that seeks to argue on simple logic heuristics for example “lower taxes are always better than higher taxes” and “giving the freedom for markets to determine decisions is the best solution whether it is interest rates, healthcare or labor wages”. The appeal to coherence is a strategy for how the ideology argues for the policies that it promise, such as combining results from studies in diverse fields of economics - Buchannan’s Public Choice (Stughart, 2020), “rational expectations” of Monetarism macroeconomic policy and Hardin’s Tragedy of the Commons (Hardin, 1968) as being somehow connected and reinforcing one another through some universal truth.
Buchannan’s Public choice and Birdsall’s “dark side” of state managed economy (Birdsall, 2010) may have resonated with a general skepticism and lack of trust in public institutions especially with regards to cost effectiveness and vulnerability to corruption. While Von Hayek’s original work was based on general advocacy for decentralization and anti-monopoly power either by the state or from large corporations, the skepticism of liberalization was asymmetric and placed a proportionately greater faith in banks and private capital as competent managers. Over time empirical evidence linking free-market policies to economic outcomes - GDP growth, foreign direct investment capital flows may be more persuasive to those who are less convinced by rhetoric and metaphors. (Miller, 2020).
Timing
The three concurrent events in the 1980’s and early 1990’s of the break-up of the Soviet Union, stagflation macroeconomic crisis in the US and the comparative success of the Asian Tigers to Latin American developing economies created the conditions for a perception of failure of the old system and an opening for the legitimacy of free-market liberalization reforms. Open borders is a central policy reform aim so liberalization compliments the acceleration of economic forms of globalization occurring during the same period. The opening of China beginning from Deng Xiaoping in the late 1970’s and globalization may also have influenced the shifting openness to the liberalization policies. The open borders for trade could accelerate the differentiation of roles between countries for advanced economies to shift to services and developing economies to build up a manufacturing base.
The success of the export-oriented, free-market Asian Tiger model from East Asian economies (in particular South Korea, Hong Kong, Taiwan and Singapore) was one of the factors contributing to the Washington Consensus. While South Korea and Taiwan retain many of the economic features from the liberalization reforms from the 90’s, they have since had their own series of political and economic reforms incorporating progressive policies of the Scandanavian welfare state (Lee, 2017). The next section reviews the story of how Singapore rose to the #1 spot as the most “Free” country and the cautious policy shifts in the aftermath of the 2011 election.
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