|"What is Wrong with the Washington Consensus?"-1
December 16, 2003[ 2 | 3 ]
The term "globalization" has for several years been used to refer to something great crowds of protestors are against; economists, in turn, find it impossible to be against "globalization," and find themselves arguing against a shadowy and irrelevent "anti-globalization" movement that, in reality, does not exist. Almost no one is "against globalization" (as if such a phenomenon were open to debate), and the real object of angry contretemps is an ideology called "The Washington Consensus." Yes, stupid rhetoric is always in abundance at public gatherings of every stripe, and I suppose it's entertaining to write columns mocking it. However, those of us seriously concerned about international economic relations really need to abandon the demagoguery associated with the word "globalization." "Anti-globalism" implies xenophobia and parochialism; whatever one may say about actual, fleshly protestors in Seattle 1999, one may not say they were either xenophobic or parochial. Likewise, many object not to the employment of people in low-wage economies, so much as the strategies employed to ensure those economies remain low-wage. In order to get at the heart of these objections, we must speak of the Washington Consensus, not "globalization." For understanding what the WC is, "What is Wrong with the Washington Consensus...?" by Paul Davidson is a useful introduction.
The term is certainly a useful one; here is a speech by John Williamson1.1 in which he unfortunately says of its critics, "There are people who cannot utter the term without foaming at the mouth." However, he does gamely enumerate its key parts (descriptions Williamson's):
(I say this because the whole object of economics is to optimize production and satisfaction given the constraints of human interests; humans are assumed to be self-regarding. If one fails to anticipate corruption—formally, if corruption is "exogenous" to the model of developing nation—then your model is insufficiently rich. It is like assuming Niger has adequate water supplies for growing rice.).
Paul Davidson's rebuttal is refreshingly blunt, to the point of being blogovian:
Post Keynesian analysis... can demonstrate that what most orthodox economists mean by a policy of fiscal discipline will neither (1) avoid the possibility of current account crises, nor (2) produce a fully employed economic system. Trying to implement the reforms with their emphasis on fiscal discipline, the liberalization of financial markets, and the free market competitive exchange rate has created some severe problems for Latin AmericaTo me, this seems obvious. It also signals that orthodox neoliberal economists, after a go at Stalinist domination of the field, really ought to go the way of Trofim Lysenko.
Williamson dismisses critics of orthodox neoliberal economic theory as advocating a sort of economic polygeny:
...There used to be a sort of global apartheid which claimed that developing countries came from a different universe which enabled them to benefit from (a) inflation (so as to reap the inflation tax and boost investment); (b) a leading role for the state in initiating industrialization; and (c) import substitution. The Washington Consensus said that this era of apartheid was overThis is certainly daring. I certainly would never attempt to defend the premise that Germany, Japan, the USA, South Korea or Taiwan flourished without a leading role for the state. If we look at the history of the USA, for example, we find the Gilded Age dominated by sky-high tariffs, the Pacific Railroads Act, and public works; then, of course, we find the period 1940 to the present an era of historically unprecedented growth—and government spending, as a share of GDP.
The crux of Williamson's defense rests on the premise that the horrible economic performance of the Latin American countries (or Egypt, or Pakistan) that adopted the WC suffered as a result of crisis brought on by ideological-doctrinaire-application of it.
No country that took the Washington Consensus as I wrote it as a panacea would have been obliged to do the sort of things that led countries into crisis—by opening up the capital account prematurely and letting money flood in and overvalue the currency, or using the exchange rate as a nominal anchor, or pursuing a procyclical fiscal policy. But neither were they warned against such foolish acts.No, at times they were actively pushed into them.
A second reason that outcomes did not match the hopes of a decade ago is that reforms were incomplete, in two ways. For one thing, some of the "first-generation reforms" were neglected [...] or incomplete [...]. In addition, there is a whole generation of so-called "second-generation reforms", involving the strengthening of institutions, that is necessary to allow full advantage to be taken of the first-generation reforms.In other words, on the one hand the WC failed because it was adopted as an ideology; on the other hand, it also suffered from not being implemented comprehensively enough. Your humble correspondent lacks the temerity to make this up. The third reason, incidentally, makes precisely no sense at all—indeed, I feel as if I have stumbled into the enterprise of fact-checking Lewis Carroll. But it seems he claims to have been stymied by focusing on income distribution. That the WC failed because of a "narrow focus... on accelerating growth without worsening income distribution" certainly comes as a surprise to your correspondent. Many critics had the impression the WC was failure for ignoring this prima facie. Unfortunately, after this, he makes almost no sense at all. Or rather, having made an absurd show of having learned from the hardship his ideology inflicted, he then sternly rebukes critics not to "return to" socialism. As an afterthought, he absently rejects industrial policy and capital controls, and likens the era before the "Washington Consensus" to one of "Global Apartheid." He proceeds to explicitly reject the possiblity of learning anything about the scope and modalities of capitalism in different societies, insisting instead on the market economy as taking only the form he insists: an impossible string of mutually-contradictory requirements that serves to absolve multilateral credit entities of any responsiblity to the nations they administer. He actually thunders, "it is high time to end this debate about the Washington Consensus"; he alone has the right to decide what criticisms of his scheme are permissible. Yet, since his list of requirements allow the technocratic managers unlimited power, through vague language, he would allow the Bretton Woods Institutions untrammeled powers to unilaterally open a country's economy to whatever trade terms benefitted the developed nations in charge. He is, not so much a lobbyist for multinational enterprise, as its prostitute.
When an economist turns a-whoring, he is worse than a whore; because at least with the whore one gets bona fide sex. An economist has only knowledge and analytical tools, and if he prostitutes those, he disserves not only the public whose interests are trampled, but also the sectional interests that employ him. The mendacity and the cult of optimism ultimately consume even the most calculating clientele.
Nor do I need to muster more wrath to deal with Williamson. Fortunately, his non-colleague (because not a gigolo) Paul Davidson does much better. While Williamson offers little helpful information in his speech, he has a track record of analysis which Davidson examines with a little more honesty. Davidson makes short work of Williamson's pretensions—maintained assiduously in editorials and reviews by Williamson—that he is no market fundamentalist. The only point of departure Williamson could actually claim is that he acknowledges shock therapy could "kill the patient," assuming the patient is a parastatal-trammeled Latin American country.1.2 More plausibly, Williamson—who taught economics in Brazil during the time of military rule there—understood that those parastatals could bite if they were "reformed" too fast: the experiences of Getúlio Vargas and of Joăo Goulart had demonstrated that.
Williamson coined the phrase "Washington Consensus" in 1989, about the time that a cluster of financial institutions (chiefly, the World Bank Group and the IMF, but also commercial banks) began to insist on these terms. It is interesting to note that the first direct elections for a president in Brazil were held that year; it had been over 35 years since the ouster of the last elected president. Just as it fell to Germany's first civilian leader ever to implement the terms of the Versailles Treaty, it would fall to Latin America's post-falangist civilian leaders to implement the new suicide pact.
In an open economy such as the ones affected by the new WC, there were a few methods by which the economy could be maintained at full employment.
If, however, the government institutes reform #4 of the Washington Consensus and permits capital funds to freely move across national boundaries, then "the authorities had no direct control over the domestic rate of interest or the other inducements to home investment, [and] measures to increase the favorable balance of trade [are]...the only direct means at their disposal for increasing foreign investment" [Keynes, 1936, p. 336] and domestic employment.Of course, "Keynesian" was a bad word. It's understandable that the objections to fiscal stimulus strategies would win the day for a time; and we can understand the likes of Williamson rejecting a return to failed development policies of the '60's and '70's. But in his repudiation of industrial policies, Williamson insists his own didn't fail; they just were applied ineptly. He is being silly; it's a pretty straightforward explanation that the 3-fold path I outlined above would fail, but it's also obvious that market fundamentalism will also fail. His own rarefied theory doesn't explain why a society like Brazil, c. 1989, should not undertake shock therapy; he just wants to take an average between (a) what pure theory says and (b) doing nothing.
(Part 2)CV; some short essays; intro to a book of essays on the Washington Consensus.) 1.2 The most familiar case of what I'm talking about is Argentina, whose parastatal sector was fascinating; it was a corporate analog of the Winchester Mystery House, a military industrial complex whose subsidiaries engaged in every variety of product or service. Like topsy, it grew through pork-barrel appropriations made by the provincial or federal governments until it exceeded 5% of GDP. Pres. Carlos Menem finally liquidated the military parastatal sector and sold several other state enterprises, such as the airline and the telecommunications monopoly, to foreign investors. But Argentina's military parastatals, while venerable and byzantine, were possibly eclipsed by the hothouse mushrooms of Brazil's Second National Development Plan (PND II, 1975-79), introduced under Gen. Geisel. Geisel and the hyper-repressive Gen. Medici presided over a military regime for which anti-Communist repression had become a cultlike obsession. Nevertheless, Geisel's advisors adopted a program of ambitious import substitution (for energy-intensive processed raw materials like aluminum, steel, fertilizer...) and public infrastructure (like the world's largest dam, Itaipu, and the country's first atomic power plant). Source: The Political Economy of Brazil, Graham & Wilson, ed.; University of Texas, 1990.
December 16, 2003[ 1 | 3 ]
My previous posting addresses the failures of the "Washington Consensus," that I've also been calling the WC. I'm really pleased by this serendipitous discovery, "What is wrong with the Washington Consensus...?" by Paul Davidson; although Davidson critiques the WC from the point of view of Keynes, I have been impressed by the fact that his criticisms demonstrate the inability of the RE/RBC2.1 models to address the real world. Naturally, we do not expect an RE/RBC economist to give any credence to a Keynesian (especially one of the old guard, like Davidson). Moreover, Williamson, in his recent articles, demonstrates that he still adheres to the RE/RBC model-tending-toward-monetarism. Very well, an understandable difference of opinion; people a lot smarter than I take either side of the debate. What I am saying is that his ideas do not hold together when addressing a forex regime. Here's why: the monetarist view, espoused by Milton Friedman, was that currencies should float. It was the natural approach to resolving problems of current account deficits-if Argentina (for example) ran a persistent balance of payments deficit, then its currency would decline in value until exports were cheap, imports dear, and trade moved to balance. As for capital flows—it was assumed that, if markets were liquid, then a steadily declining Argentine peso would merely lead to a shift in the investment/consumption decisions by Argentineans. The ability of markets to adjust depended on the free movement of the currency, not countercyclical intervention.
So while the monetarist favored a float (thereby enabling steady domestic expansion of the money supply), the RE approach was that money was neutral; and that neither fiscal nor monetary policy made any sense. They argue that the real exchange rate stays constant anyway—it is comparative price indices in different countries that cause the big fluctuations in nominal exchange rates. The most famous paper on the topic, by Neil Wallace, is "Why markets in foreign exchange are different from other markets" which explains that the only feasible regimes are either floating exchange rates with capital controls or else fixed exchange rates with monetary and budget policy coordination (with the latter preferred). This actually puts the financial authorities of the world in the job of maintaining exchange rates, and ignoring the business cycle. So the RE/RBC theorists aren't going to tell them what to do about growth or inflation—these things are determined by price shocks anyway.
For all that, Williamson was architect of a crawling float policy, something that, to my inaugust mind, makes sense only if you are a Keynesian.
That's because the Keynesian has the IS-LM diagram and a set of homogenous linear equations that can be solved for an optimal nominal exchange rate (from which we can determine the best real exchange rate, based on interest rates and other things affecting domestic inflation). If you believe in sticky prices and underconsumption (and capital flight), which seems like a good thing to do, then you're bound to a set of other conclusions, viz., that there really is an optimal value of the currency at any given point in time. This binds you therefore to fiscal policy also.
There are other matters as well, such as the conflict Davidson already mentions between fiscal discipline and liberalized interest rates (or, as Williamson decided later, total absence of capital controls) and a competitive exchange rate. I can see how you could have two of those, but all three? Here's the dilemma:
The WC, in other words, is not a plan. I have never heard of an economic theory under which the plan can be achieved, even if the political machinery is totally acquiescent. It is neither monetarist nor RE/RBC because there's a "competitive" exchange rate in the picture. But it certainly is not Keynesian, either, because there's no pro-active fiscal and monetary policy, and no capital controls. Perhaps I'm being unfair, because in the context Williamson is writing, it is true there was an official exchange rate that was excessively high, but there were other structural reasons for these imbalances that don't appear in the model. And finally, it seems obvious that there ought to have been something in the analysis that accounted for an optimal transition, and there was no such thing.
(Part 3)IS-LM approach in favor of a return to neoclassical ideology. RE is based on the assumption (or rather, the assumption that the following assumption does not lead to consistent errors) that actors in an economy are able to make reliable assumptions about key economic variables, such as prices and interest rates. So efforts to smooth out business cycles will lead to failure ("policy ineffectiveness proposition") because, if the government runs a big budget deficit to restore balance, then taxpayers will save more in anticipation of future tax hikes, or else buy bonds in anticipation of future increases in real interest rates.
Conversely, if the central bank lowers interest rates to stimulate the economy, the bond markets will—over time—maneuver to capture 100% of the effects of the stimulus/disinflationary measures. Either you have a "monetarist" who manages to get a steady growth in the money supply (in which case, everyone knows the money supply will expand and plan accordingly); or you have a recurring game of chicken in which central bankers have to convince bond markets and labor unions that they are serious about fighting inflation (or else, fighting high interest rates). If this sounds unlikely, it turns out to be untrue as well. See Christina and David Romer, "Does Monetary Policy Matter?" NBER Macroeconomics Annual; see also Rational Expectations, 2nd Ed., Steven Sheffrin, Cambridge University Press, 1996. I've read a big chunk of the latter book and it's really excellent.
RBC (Real Business Cycle) Theory employs a model developed by a cluster of Nobel laureates, the Ramsey-Cass-Koopmans model (sometimes called an AK model.) This is a mathematically intensive explanation of how an aggregated economy responds to price shocks. IMO, theory uses terribly unhelpful assumptions (viz., that there is only one equilibrium and that the entire economy can be simulated with a large number of identical "average" people). I'll address this in greater detail in a future entry.
December 17, 2003The Washington Consensus and Income Inequality
Another go at this essay by Paul Davidson. Davidson has a lot to say about the overall development policy in praxis since 1989, and a lot of it is boiled down for economist readers. He summarizes his objections to the "Washington Consensus" very rigorously, and I'll be going through these with my own views interspersed.
We left off complaining about the logical inconsistencies of the so-called "Washington Consensus," and John Williamson's defense of them. We mention a parting shot before moving on to Davidson's alternatives.
First, here is a different sort of demand curve from the usual. There are two on the graph below, and they both slope upward because they relate demand to income (not price to quantity demanded). The red line represents the market for OECD exports, such as BMW sports sedans or Boeing 777 airliners. The blue line represents demand for Latin American exports. As the two lines diverge, the Latin American countries can maintain a balance of trade only if they lower prices, which can only be done by lowering the real exchange rate. This might work if the Marshall-Lerner Conditions apply, but there are many reasons to suspect they do not.3.1 And even if they do, there will still be a steady deterioration in the living standards of Latin Americans.
Such an outcome, to say the least, would be dreadful for American workers; downward pressure on wages would continue, while demand for American products would decline. Other trading partners in the OECD, most notably Japan and China, have hefty current account surpluses built into their industrial policies, and they do not represent adequate export markets for American goods. WHAT WOULD WORK BETTER?
As Davidson points out, however, the failure of ostensibly state-planned economies made the WC popular amongst economists. It wasn't just the Warsaw Pact countries, either ("jacobinist" state capitalism); it was also the falangist military bureaucracies of Brazil & Argentina, or the intensively planned economies of Japan and South Korea. Many developmental strategies have been undertaken all over the world, including ones which were not culturally appropriate.
Davidson organizes his thoughts by addressing the fallacy of demanding reforms (1) that liberalize international capital markets and (2) urge changes in the exchange rate to make industries more competitive. According to him, it is these two "reforms" that have been a primary cause of the failure of Latin American nations to grow at a rate equal to their resource potential. To formulate a rational alternative, he cites this outline from Keynes:
We need an instrument of international currency having general acceptability between nations .... We need an orderly and agreed upon method of determining the relative exchange values of national currency units.... We need a quantum of international currency... [which] is governed by the actual current [liquidity] requirements of world commerce, and is capable of deliberate expansion.... We need a method by which the surplus credit balances arising from international trade, which the recipient does not wish to employ can be set to work... without detriment to the liquidity of these balances (Bretton Woods, p.168)Such a system is quite ambitious, although it must be pointed out that as I write this, the BIS, the WBG, and the IMF supply the backbone to much of what would be required.3.2
Our object would be to create a clearing and control system for international capital. The purpose would be to prevent gaps from appearing in aggregate demand, while also preventing catastrophic reversals in capital flows. Davidson outlines such an organization, provisionally named the "International Clearing Agency" (ICA), which would supersede the BIS as a clearing house among central banks. It would also enable a large variety of capital controls, among which member states could select an optimum. In this particular version, there would be issued a universal reserve and interbank transaction unit (hereafter, ICMU), and member nations would set an optimal exchange rate with respect to it upon entry. The nub of the concept involves a plan to stimulate the lending of unused balances (accumulated in the ICA by member states running current account balances).
The rest of the paper is devoted to this scheme, which is certainly fascinating and complex, but which, alas, I do not have time to scrutinize in adequate detail. It seems to me to pose certain problems, insofar as it requires member states to give up a lot of fiscal sovereignty, in exchange for the ability to impose capital controls.
The important thing is to make sure that continual oversaving15 by surplus nations can not unleash depressionary forces and/or a building up of international debts so encumbering as to impoverish the global economy of the 21st century...[If] the surplus nation does not spend or give away these credits within a specified time, then the [ICA] would confiscate (and redistribute to debtor members) the portion of credits deemed excess. This last resort confiscatory action by the managers of the clearing agency would make a payments adjustment via unilateral transfer payments in the current accounts. (p.17)While Davidson's (and Keynes') rationale for this makes a lot of sense, I think it leaves the production decisions of the deficit nations (chiefly, the USA) out of the loop. These are part of the problem. Davidson's approach for rich deficit nations seems to me to be implausible:
If it is a relatively rich country, then the deficit nation must alter its standard of living by reducing its relative terms of trade with its major trading partners. Rules, agreed upon in advance, would require the trade deficit rich nation to devalue its exchange rate by stipulated increments per period until evidence becomes available to indicate that the export-import imbalance is eliminated without unleashing significant recessionary forces (p.22)This has the shortcoming of leaving intra-national market forces out of the equation.
He also doubts the Tobin Tax would pose a viable alternative; transaction costs have been shown to increase, rather than mitigate, market volatility. He also rejects the lender of last resort approach (LOLR) strategy, which has so far failed to result in heightened confidence; ideally, the LOLR regime of the IMF, et al would stop runs on currencies the way the FDIC stopped runs on banks, but that has yet to materialize.