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Washington Consensus revisited

S. Venkitaramanan

Mr JOHN Williamson, who in 1990 coined the term `Washington Consensus', has revisited the concept in an interesting article in the World Bank Research Observer, August 2000. Mr Williamson is a distinguished economist, who has written extensively on the s ubject of economic development. A pleasant interlocutor, he is well known for his ability to elicit consensus from diverse contributors.

The last time I had the privilege of attending a meeting in Colombo, in which he played a leading role, was after the South-East Asian crisis, when he along with Mr Joseph Stiglitz and many other distinguished economists, including the late Mr Mahbub Haq , the Pakistani economist, discussed, among other things, the status of financial sector reform in Asia.

I remember the conference particularly, in which both Williamson and Stiglitz ribbed each other good-humouredly on the Washington Consensus. By then, Stiglitz had made public his reservations about some of the aspects of financial liberalisation that the Washington Consensus comprised.

`Washington Consensus' is a term Williamson used to refer to the lowest common denominator of policy advice being addressed by the Washington-based institutions, directed to Latin American countries as of 1989. The term now refers the whole developing wo rld and encapsulates the experience of the 1990s. The original version of the Washington Consensus -- what would represent the first generation of economic reforms -- is now extended to the rest of the world -- and can be summarised in the follow ing ten propositions:

*Fiscal discipline

*A redirection of public expenditure priorities toward fields offering both high economic returns and the potential to improve income distribution, such as primary health care, primary education and infrastructure

*Tax reform (to lower marginal rates and broaden the tax base)

*Interest rate liberalisation

*A competitive exchange rate

*Trade liberalisation

*Liberalisation of inflows of foreign direct investment

*Privatisation

*Deregulation (to abolish barriers to entry and exit)

*Secure property rights.

As Williamson himself observes, the need for the first three elements is widely accepted by economists, as part of rational economic policy-making.

One may suspect that these elements are not quite consistent with the aims of poverty reduction, an issue that appeared on to the radar screen of the world's multilateral institutions, particularly after the East Asian crisis. Emphasis on fiscal discipli ne has often been inconsistent with larger provisions for health care and education and has also led to reduction of provisions for the welfare of the poor.

The need for `juggling' these conflicting goals makes the making of fiscal policy an interesting challenge. The Consensus demands fiscal prudence. Poverty reduction oftentimes dictates a high provision for subsidies and relief programmes. To reconcile th ese requirements often means giving up one or other of the goals.

Williamson claims that he had reservations about interest rate liberalisation as a plank of the reform package of the Washington Consensus. He concedes that Stiglitz, who has had many reservations, has a point when he argues that interest rate liberalisa tion should come towards the end of the process of financial liberalisation.

Many of the East Asian countries succeeded in their economic development because of their resort to directed credit. While there have been counter-arguments against such directed credit, it cannot be denied that the policy of directed credit did play an important part in ensuring Korea's successful emergence from a state of under-development to a place amongst the developed countries.

Williamson has included competitive exchange rate as one of the elements in the Washington Consensus. He is personally in favour of an intermediate regime of limited flexibility, meaning thereby a move towards targeted exchange rates. The use of the term `competitive exchange rate' suggests that Williamson is perhaps in favour of a rate that is slightly weaker than what would otherwise be possible. As Prof T. N. Srinivasan reminds us in his perceptive comments on Williamson, the term `competitive exchan ge rate' reminds us of the practice of competitive devaluation of many countries in the post-First World War era.

The East Asian economies and Japan owed their export-led economic growth, at least in part, to this policy. It is also a fact of history that the missions sent by the multilateral institutions to countries in distress did insist on their devaluing, as an immediate solution to their problems. Their advocacy of devaluation, in fact, led to the disrepute of the Washington Consensus, in general, to promote a better BoP scenario.

In this background, a competitive exchange rate, meaning a slightly undervalued exchange rate, if not sharply devalued currencies, is understood to be part of the Washington Consensus -- at least in the developing world as a whole. This was confirmed in the immediate aftermath of the Asian crisis, when country after country was advised to devalue.

Trade liberalisation is a sensible policy reform. It is, however, questionable whether trade liberalisation is appropriate regardless of the specific circumstances of the economy or the time horizon involved. The current experience of India, consequent o n the removal of quantitative restrictions, shows that it is difficult to generalise and advise that trade liberalisation per se is good for all countries in all circumstances.

The conclusion in favour of free trade is critically dependent on the response of the more powerful global partners. Constraints to the free flow of goods and services, especially from developing countries, continue to dominate international trade practi ce.

Williamson is aware of the doubts whether Washington Consensus by itself promotes reduction of poverty. If the Washington Consensus interpreted to mean ``let us bash the state, the markets will resolve everything,'' it will not help in this goal. Such ma rket-dominant policies do not offer an effective agenda for reducing poverty, which demands concrete efforts to build the human capital of the poor. The Washington Consensus, in its popular version, fails to address the issue of rectification of inequali ties and reduction of deprivation.

Privatisation is one of the important pillars of the Washington Consensus. But privatisation is not without its problems. While substantial knowledge has been generated as to what methods will work and what will not in privatisation, it cannot be the cas e that privatisation is always efficiency-enhancing. Particular care has to be taken to ensure that privatisation is accomplished with great care for transparency and equity.

The Washington Consensus comprehends what we now call the first generation of reforms. Now that we are engaged in the second generation of reforms, it is important to look back on what the first generation has accomplished. There has been an over-emphasi s on fiscal balance, which has led to cutting down of public investment, especially for infrastructure.

While it may be true that public sector investment for infrastructure has not always been efficient, we have to reckon with the political reality that the alternative, private sector investment, does not seem to be forthcoming in adequate measure, given the long gestation period and uncertain returns that infrastructure gives. This is one of the dilemmas which India is facing as a consequence of first generation of economic reform a la the Washington Consensus.

It has now been recognised that though the elements of the reform package are important in themselves, the quality of governance is equally important. The World Bank has recently concentrated its attention on various aspects of this element. It is, howev er, questionable whether an external thrust, such as one from the multilateral financial institutions, can help enforce a decent respect for the appropriate models of governance. Governance is essentially a political issue and appropriate policies and pa tterns have to be `owned' by the countries that are involved in the reform process.

If governance and democracy are grafted on the Washington Consensus, it may be a case of overburdening it. The Washington Consensus already suffers from the association with institutions located in Washington. What is missing in the debate on Washington Consensus is the lack of `consensus' between the countries sought to be aided under the reforms process and the institutions that generate and pursue the policy package. It is obvious that, in a democracy, economic reforms involve creation of a political consensus at the level of the different parties. Populist programmes have an appeal that economic reforms do not have. Enthusiasts for the Washington Consensus cannot ignore the ground reality that every economic reformer has to fight an uphill battle t o gain acceptance.

The price that economies have to pay for a flawed economic model is too high. The democratic process is unforgiving. Any failed economic reform creates a backlash, which makes further efforts at reform extremely difficult. Not all the billions of dollars that the IBRD and the IMF offer can erase this essential political fact. The Washington Consensus needs a democratic consensus in the countries of the developing world.