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 and a couple of posts back I felt the need to supply a link reminding readers what it was. Then, I linked to a speech by John Williamson^1.1 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):

1. Fiscal Discipline. This was in the context of a region where almost all the countries had run large deficits that led to balance of payments crises and high inflation that hit mainly the poor because the rich could park their money abroad.
2. Reordering Public Expenditure Priorities. This suggested switching expenditure in a pro-poor way, from things like indiscriminate subsidies to basic health and education.
3. Tax reform. Constructing a tax system that would combine a broad tax base with moderate marginal tax rates.
4. Liberalizing Interest Rates. In retrospect I wish I had formulated this in a broader way as financial liberalization, and stressed that views differed on how fast it should be achieved (again, descriptions are Williamson's—JRM)
5. A Competitive Exchange Rate. I fear I indulged in wishful thinking in asserting that there was a consensus in favor of ensuring that the exchange rate would be competitive, which implies an intermediate regime; in fact Washington was already beginning to subscribe to the two-corner doctrine.
6. Trade Liberalization. I stated that there was a difference of view about how fast trade should be liberalized (Really, descriptions are Williamson's—not mine—JRM).
7. Liberalization of Inward Foreign Direct Investment. I specifically did not include comprehensive capital account liberalization, because that did not command a consensus in Washington.
8. Privatization. This was the one area in which what originated as a neoliberal idea had won broad acceptance. We have since been made very conscious that it matters a lot how privatization is done: it can be a highly corrupt process that transfers assets to a privileged elite for a fraction of their true value, but the evidence is that it brings benefits when done properly.
9. Deregulation. This focused specifically on easing barriers to entry and exit, not on abolishing regulations designed for safety or environmental reasons.
10. Property Rights. This was primarily about providing the informal sector with the ability to gain property rights at acceptable cost.

(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 America

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 over

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.
[emphasis mine—JRM]

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.

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 João 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.

1. It could implement huge public spending projects—projects which, in Brazil, had brought on a 1986 debt crisis
2. It could manage trade, as the generals had sought to do by targeted investment and tariffs
3. It could control the real exchange rate through interest rates and capital controls

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.

The orthodox policy for improving a nation's trade balance is to make the domestic industries more competitive either (1) by forcing down nominal wages including fringe benefits (i.e., liberalizing or "freeing up" the nation's labor market) to reduce labor production costs and/or (2) by encouraging a decline in the nation's exchange rate to a more competitive level. Keynes (1936, p. 338) warned that the domestic employment advantage gained by pursuing a competitive exchange rate policy (reform #5) to encourage export-led economic growth "is liable to involve an equal disadvantage to some other country" (p.5)

(Part 2)

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/RBC^2.1 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:

1. fiscal discipline means balanced budgets; in a Latin American country, a budget deficit can stimulate the economy—but it can also lead to a run on the securities, and therefore, the currency, of the affected country.
2. liberalized interest rates—i.e., no capital controls—means no monetary policy, and in a very sensitive open economy, not much control over the exchange rates. Sure, the government can announce each month a crawling peg, and then buy/sell its own currency to maintain that peg, but nowadays that gets extremely expensive because of the size of daily forex transactions. Interest rate regimes offer more power.
3. competitive exchange rate, meaning the country keeps its exchange rate low "enough." What is "enough"? I suppose this means, so low relative to the USD that it runs an eternal trade surplus. That, of course, assumes the Marshall-Lerner Conditions apply.

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)

[ 1 | 2 ]

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.
Obviously, it will also worsen the debt service load for Latin American countries and pit them against each other in a "race to the bottom" (i.e., lowest real exchange rate).

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)

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)

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)

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.

KINDRED THINKERS
It should come as no surprise that many economists and policy analysts have conceived of the need to replace the WC with something both more robust and more human. L.A. Gillespie, at Random Ideas, has an outstanding listing of these. Here is his other web log, and here is a student paper he praised highly.

NOTES 3.1 Some reasons why the Marshall-Lerner Conditions might not apply: items imported by Latin American countries are likely to include things that are essential, either to life itself or to the production of exports. For example, a decline in the real exchange rates of Latin American countries won't affect the energy cost component of exports. And whilst this regression analysis of import-export elasticities (PDF; focuses on biggest economies) demonstrates that elasticities do increase over time, we would be talking about a steady decline over time-repeated, jerky downward movements in the exchange values of LA currencies, usually coming two quarters after a trough in the American business cycle.