WHEN they criticise globalisation, sceptics are not just talking about economic integration across borders, or about the particular economic policies, such as liberal rules on trade and international investment, that directly facilitate it. They have in mind a much larger set of economic nostrums and institutions: the policies of the “Washington consensus”, as it is known, and the international bodies, notably the International Monetary Fund and the World Bank, that strive to put it into effect.
The term “Washington consensus” was coined by the economist John Williamson in 1989. He called it that because of the support it enjoyed from the American government and (not coincidentally) from the Fund and the Bank, the big Washington-based institutions. He said it stood for ten policies. Measures to promote trade and FDI were high on the list, but the new orthodoxy, as he described it, also ran to the following: fiscal discipline (ie, smaller budget deficits), fewer subsidies, tax reform, liberalised financial systems, competitive exchange rates, privatisation, deregulation and measures to secure property rights.
In the view of many sceptics, this broad “neo-liberal” agenda has been deliberately designed to serve the needs of the rich at the expense of the poor. The sceptics' thinking on trade and foreign investment has already been discussed; their view of the rest of the formula is just as scathing. Fiscal discipline, curbs on subsidies and increases in taxes—measures long emphasised by the IMF in its dealings with distressed developing-country borrowers—directly hurt the poor, they say. Privatisation, financial liberalisation and industrial deregulation work to the same effect, by delivering windfall profits to domestic and foreign speculators, by stripping the state of its assets and by weakening rules that protect consumers and workers from abuse.
Error and muddle have obscured valid criticisms of the “Washington consensus”
These policies are forced on poor-country governments regardless of their own views and priorities, incidentally undermining democracy in the third world. In the longer term, this kind of development—in effect, on terms dictated by the rich countries—saddles the developing countries with crippling debts. It also exposes them to the crazy fluctuations of the global business cycle. East Asia, one-time exemplar of the Washington model, discovered that to its cost; now Argentina, another darling of the Washington development establishment, is on the rack for the same reason. Insupportable debts and chronic instability worsen the developing countries' dependence on aid, and allow the IMF to tighten the screws even more vigorously next time, at the direction of American bankers. In every way, sceptics believe, the Washington consensus is a calculated assault on the weak.
Extreme as this caricature may be when taken as a whole, it contains some truths—which is why, for all its absurdity, it is recognisable. The idea that the Washington establishment is engaged in a deliberate conspiracy to oppress the third world may be nonsense, but there have been mistakes, big and small, and unintended consequences aplenty. The problem is that the valid criticisms are buried under a heap of error, muddle and deliberate distortion. The IMF, the Bank and America's Treasury Department would all feel much more threatened if the shards of intelligent criticism could be filtered from all the rubbish and gathered together.
One of the clearest lessons for international economics in the past few decades, with many a reminder in the past few years, has been that foreign capital is a mixed blessing. This stricture does not apply so much to FDI because, unlike debt, FDI does not need to be serviced and cannot flee at short notice. As a result, providers of FDI themselves bear most of the financial risk attached to the investment, but this advantage comes at a price. Over the long term, FDI is a more expensive form of finance than debt because the outflow of remitted profits usually gives this kind of investor a bigger return than a foreign bank or bondholder could expect to receive. All the same, FDI is not only less risky for the host country, it is also more productive, as noted earlier, because of the technology and techniques that come with it. It is expensive from the host country's point of view, but good value.
Other forms of foreign capital, and especially short-term bank debt, have led many a developing country into desperate trouble. Because of the debt crisis, the 1980s were a lost decade for Latin America; today, in different ways, Argentina and Brazil are both in difficulty again because of debt. The financial crisis of the late 1990s set back even the East Asians, up to then the best-performing of all the developing countries. Why has this happened—and why so often?
Borrowers, obviously, have to take their share of the blame for borrowing too much, though that is rarely the whole explanation. Governments that borrow heavily in order to finance recklessly large budget deficits are plainly at fault. There was a lot of that in the 1970s and early 1980s. The case of corporate borrowers in developing countries is more complicated. They may sometimes borrow amounts which seem individually prudent given certain macroeconomic assumptions—such as no devaluation of the currency—but which become collectively insupportable if those assumptions turn out to be wrong. This happened in East Asia in the 1990s, with the further complication that much of the borrowing was channelled through domestic banks, meaning that the ultimate borrowers were unaware of the system-wide exchange-rate risk.
Sometimes, therefore, developing-country banks have been at fault as well—and their governments too, for failing to regulate them effectively. Some governments have also allowed, or actively encouraged, too much foreign borrowing by firms, with or without the intermediation of domestic banks and other financial institutions. Even some governments that have taken care to keep their own borrowing in check have been guilty of these failures of regulation and oversight.
But at least as much of the blame for the developing world's recurring debt traumas lies with rich-country lenders and, at one remove, rich-country governments. Modern banking operates, notoriously, under the persistent influence of moral hazard. This arises because deposit-taking banks are intrinsically fragile operations—and because governments are reluctant to let them fail. Banks are fragile because they promise depositors to repay deposits on demand and in full, even though they are unable to keep that promise if a significant number of depositors decide to exercise their right all at once. To avoid the risk of bank runs, which is high given the design of the contract with depositors, governments arrange deposit-insurance schemes, and other forms of assurance, including the doctrine of “too big to fail”.
There are good reasons for this. If a bank fails, it may take other banks and enterprises, not to mention depositors' savings, with it; the broader payments system may also be imperilled. Historically, bank failures are associated with economy-wide recessions; for example, they helped to bring on the Depression of the 1930s (which was the inspiration for the modern deposit-insurance model). But the upshot is that banks are systematically protected from the consequences of their reckless behaviour.
Modern banks keep a far smaller fraction of their deposits as reserves than their historical forebears. Depositors have no incentive to supervise the banks by keeping an eye on reserves or by withdrawing money from the ones that are taking too many risks: their deposits are protected in any case. And banks have a correspondingly big incentive to compete aggressively for deposits which they can lend at high interest rates to risky projects. It is a formula for ruin—and, despite the efforts of regulators to measure and curb those risks, it keeps on working exactly as you would expect. In almost every case of spectacular boom and bust in recent years, in rich and poor countries alike, an exaggerated cycle of banking greed and fear has been a principal cause.
So when sceptics accuse rich-country governments of being mainly concerned with bailing out western banks when financial crisis strikes in the third world, they have a point. The pernicious logic of “too big to fail” applies in the international context as well as the domestic one. If you are going to go bust, make sure you are a big developing country rather than a small one, with debts large enough to threaten catastrophic damage to America's financial system. That way you can be assured of prompt attention.
Until the intractable dilemmas of global bank regulation have been resolved—supposing they ever can be—the hazards of borrowing from abroad do argue for greater caution than poor-country borrowers have often used, or been advised to use by the IMF and the World Bank. The confidence with which the Fund and the Bank advised, or required, countries to abolish capital controls now looks misplaced in many cases.
The policy was doubtless well-intended. There is no question that moderate inflows of debt can speed development. This is why a good credit standing is a valuable asset for a developing country, and why too ready a willingness to default on debt usually proves self-defeating. But if bank regulation in rich countries leaves much to be desired, in many poor countries it is even worse. No doubt it would be best to bring financial regulation in developing countries up to the standard, such as it is, of regulation in America and Europe. But that is easier said than done. In the meantime, taxes or controls on short-term foreign-currency inflows, of the kind Chile has used with success, may well be better for some poor countries than the alternatives of, on the one hand, no inflows at all and, on the other, completely unrestricted inflows intermediated by a weakly or corruptly regulated domestic financial system.
The sceptics' attacks on the Fund and the Bank are for the most part ill-conceived
In many other respects, however, the sceptics' attacks on the Fund and the Bank are ill-conceived. The IMF, especially, is criticised for sending its experts into developing countries and commanding governments to balance the budget in ways that assault the poor—by cutting spending on vital social services, ending subsidies or raising taxes on food and fuel, levying charges for use of water, and so on down the list of shame.
Measures to curb budget deficits are often unavoidable by the time the Fund is called in. The only way to reduce a budget deficit is to raise taxes or cut public spending. In many developing countries, where tax systems are narrowly based and unsophisticated, governments may have few options in deciding how to go about it. It would not be in the political interests of the Fund or the Bank to recommend measures that fall heavily on the poor if there were an obvious alternative.
However, the Fund, especially, may have invited much of the criticism it receives in this respect because it specifies policy changes in such detail. The IMF should strenuously avoid letting itself be seen as running the country, giving the government instructions and telling workers and voters to get lost. On the other hand, many sceptics seem to be under the impression that all was well in the countries concerned until the Fund barged in. The Fund turns up only when things have already gone very wrong indeed—and only when the government in question has asked for its help. That last point is surely worthy of more attention than the sceptics pay to it. If governments find the Fund's conditions so oppressive, they always have the option of refraining from asking for its help.
Governments know that the alternative to the Fund's intervention would usually be an even sharper contraction of public spending (including on social services) and/or an increase in taxes (including on things the poor need to buy). By the time the IMF is called in, the question whether to curb government borrowing is not so much a matter of weighing, as sceptics suppose, the case for laisser faire against the demands of social justice. Often, in the good-faith judgment of the IMF's officials, it is just an inescapable necessity if the economy is to be stabilised. And at times of impending economic collapse, stabilisation is very much in the interests of the poor, who suffer most during slumps.
In fact, most of the policies of the Washington consensus serve, or are capable of serving, the interests of the poor directly, not merely by promoting growth. If governments have been at fault in defending that agenda, it has mainly been in failing to emphasise this. The centrepiece of these policies, fiscal discipline, is sometimes necessary to avert an economic calamity; but even in more normal times, the alternative to steady control of government borrowing is usually high inflation. That, all the evidence shows, hurts the poor more than anyone else.
As noted by Mr Williamson back in 1989, the consensus called not just for fewer subsidies, but for new priorities in public spending, especially more effective support for industry and more spending on education and health—priorities intended to help the poor which the Bank has tried hard to put into practice. The need to broaden the tax base, so as to support additional public spending without destabilising the economy, is another idea that favours the poor, because there is no other way to provide the resources necessary to pay for effective safety nets. Deregulation and improved property rights can also make a real difference to the poor. As the work of Hernando de Soto has shown, it is the poor who suffer most from obstacles to small-scale enterprise and insecure titles to land.
Many sceptics might warm to the Fund and the Bank if they paid more attention to the criticisms directed at the two institutions from the political right. Conservatives worry not so much because the Fund is too mean, or the Bank too keen on market economics, but rather the opposite: they complain that both are engaged in throwing good money after bad. Worse than that, critics on the right argue, the two institutions reward the bad policies that got the patients into trouble in the first place, thereby creating their own kind of moral hazard.
If the Fund and the Bank were simply shut down, as many sceptics and many conservatives would wish, the flow of resources to the developing countries would certainly diminish, at least in the short term. The world economy would be a harsher place for the poor countries. The conservatives argue, in effect, that this would be good for them in the longer term. Those sceptics who favour slower economic growth for the third world would also be gratified, presumably, if the Fund and the Bank packed up. But it is hard to see what those who are not opposed to development as such see in this course.
The IMF and the Bank have certainly made mistakes. They have had spells of over-confidence, though they cannot be accused of that at the moment. Noted scholars such as Joseph Stiglitz, a former chief economist at the World Bank, have criticised them for technical incompetence, and for theological devotion to discredited economic theories; but other economists have argued in their defence, saying, plausibly, that they have done their best in difficult circumstances. They have certainly neglected the importance of allowing governments to “own”, and take responsibility for, their policies—a mistake which supplicant governments, anxious to deny responsibility, have usually been keen to encourage. But the Fund and the Bank are aware of this criticism, and are trying to do something about it.
Other improvements in the way the international financial institutions work are surely called for. Many different panels of experts have produced countless proposals, big and small, and some of these are being taken up. Overall, a shift of emphasis is needed. Now that many developing countries have access, for good or ill, to the global capital markets, the Bank needs to focus on disseminating knowledge rather than money. And for both political and economic reasons it would be better if the Fund, for its part, specialised in providing liquidity during emergencies, rather than development finance, subject to simple financial conditions rather than immensely detailed policy blueprints.
The institutions themselves have gone far to acknowledge their mistakes, and the need for reform. In view of this, the ability of the sceptics to maintain their hysterical animosity toward the institutions is surprising. In its way, it demands a measure of respect.
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John Williamson's website has links to recent papers and an explanation of the term “Washington Consensus”. The World Bank, IMF and the WTO have information online. The economy ministries of Brazil and Argentina provide details on their respective economies.