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The Bear's Lair: No consensus on consensus

By MARTIN HUTCHINSON, UPI Business and Economics Editor

WASHINGTON, Sept. 30 (UPI) -- The World Bank and International Monetary Fund meetings last weekend, as recession scours the world economy, were dominated by an overwhelming but largely unasked question: does the "Washington Consensus" work?

The Washington Consensus, as originally propounded by international economist John Williamson in 1990, consists of a set of free market but middle of the road economic policies, that the IMF and World Bank use as a template when judging Third World economies. Its highlights include the following:

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-- Fiscal discipline, but with no preference between achieving this through higher taxes or lower spending

-- A redirection of public spending towards areas with a high economic and social return, such as public education, public health and infrastructure

-- Broadening the tax base

-- Liberalizing interest rates

-- A competitive exchange rate, and free movement of trade and foreign direct investment

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-- Privatization and deregulation in areas where there are barriers to firms entering and exiting the business

-- Secure property rights.

Much of this, in particular secure property rights, broadening the tax base and liberalizing interest rates, is entirely unexceptionable.

Nevertheless, there are two problems with it: it provides a "one size fits all" approach to economic development, and in a number of instances, it appears not to have worked.

Taking the most difficult case first, it is clear that in Africa, the Washington Consensus is inadequate as a solution to the continent's problems. Education levels in Africa are chronically low, health has always been poor and has been made very much worse by the AIDS crisis, and government is corrupt and in many cases genocidal.

Balanced budgets are irrelevant to Africa's problems, since in most cases government expenditure, on both items the Washington Consensus considers of low priority (such as armaments) and embezzlement by the political elite, simply expands to fill the resources available.

To the extent that international financing is available, most African countries take it, since they rely in any case on eventual repudiation of the debt through such mechanisms as the heavily indebted poor countries initiative. To most African governments, every year is "Jubilee 2000."

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The solution for Africa is long and tortuous. It mostly consists of providing aid for the major humanitarian crises and cutting off any other funding to governments that do not provide at least a Botswanan level of competence and integrity.

Providing loan finance that is not expected to be repaid merely compounds the problem, and perpetuates the rule of gangsters such as Robert Mugabe. The Washington Consensus is not so much wrong for Africa as irrelevant, at its present stage of economic and political development.

In Asia, the crisis of 1997-98, and its aftermath have given the Washington Consensus at least a partial victory, for which the IMF and World Bank have duly congratulated themselves on a number of occasions. Nevertheless, on closer inspection the record is mixed.

Indonesia, which has attempted to follow Washington's policy recommendations fairly closely, remains a basket case with very little foreign investment, whereas Malaysia's Mahathir Mohamad, who repudiated Washington in 1999 and pursued an alternative autarkic policy of independence from international financial markets, has engineered perhaps the best recovery in the region.

Admittedly, there are other factors involved -- the removal of Suharto in Indonesia was always going to be difficult and none of his three replacements has been convincing.

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Nevertheless, the unpopularity of the Washington-beloved Kim Dae-jung in South Korea, and the election and subsequent successes of the Washington-distrusted Thaksin Shinawatra in Thailand suggest that much more has been going on in Asia than has been mandated by Washington.

In fact, Washington's policies for Asia have generally been confined to three areas: devaluing the exchange rate (sensible) reforming the banking system (inevitable after a real estate crash but only marginally beneficial) and balancing state budgets (beneficial in countries where the state remains small compared with the economy as a whole, but much less so in countries such as the Philippines and Indonesia where the state has grown).

The policy of Thaksin and Mahathir, of taking advantage of the weak exchange rate to build much larger local small business sectors, focused on the domestic market and largely independent of foreign investment, is almost certainly the right way forward, but it is nowhere to be found in the Washington playbook.

In Eastern Europe and the former Soviet Union, the Washington Consensus has produced economic growth levels far lower than had been hoped for a decade ago, for one very good reason: balancing the budget, as has been the central focus of Washington policy in the region, cannot deliver economic growth if public spending is too high.

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These countries, by definition, began the 90s with public spending close to 100 percent of gross domestic product. Even now, after a decade of privatization, much of their industry remains in the public sector, while other companies have been privatized to regime cronies, who have simply looted the assets.

Public spending absurdities such as the habit, in many of these relatively poor countries, of retiring the population on a state pension at the age of 55 or even earlier have not been attacked with sufficient vigor. Instead, when budget balancing has needed to be done, it has been carried out by raising taxes from levels that are already generally intolerable.

The result has been that governments committed to the free market, which have seriously attempted to reduce the size of the public sector (and have even reduced public sector deficits below the levels demanded by Washington), haven't been rewarded for this policy.

Instead, Washington has in a number of instances (notably Croatia and Macedonia) even penalized such governments by cutting off funds, in an effort to secure the election of "social democrat" (generally neo-Communist) alternatives that, with the help of larger allocations of Washington money, are able to continue providing excessive social services and thus perpetuate their electoral appeal.

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The Washington Consensus, which avoids the "political" distinction between increasing taxes and reducing government spending, has in many of these countries been thoroughly destructive, perpetuating the ancient regime and obstructing market based reform.

Finally, we come to Latin America, where the Washington Consensus is currently most questioned. The criticisms come from both sides: the left complains that privatization has largely been to political cronies, and has not greatly benefited the local economies, while the right complains that public sectors in Latin America, and still more Latin American levels of debt, remain wholly excessive and should have been dealt with.

Both criticisms have merit. There is no doubt that Argentina and Brazil in the 90s, when things were going well, should have taken an axe to their public sectors. Both countries have GINI (inequality) coefficients among the highest in the world, but their public sectors, homes of strongly unionized, protected sinecures paying wages far above the private sector norm, are here part of the problem, not part of the solution.

Since the regimes of Juan Peron in Argentina, Getulio Vargas in Brazil and Lazaro Cardenas in Mexico, now more than 50 years ago, Latin American economic development has been corrupt and autarkic, with resources flowing almost entirely through the public sector, where heavy regulations and sticky fingers make sure that most of them are diverted to illicit uses.

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The failure in Mexico of the reforming administrations of Ernesto Zedillo and Vicente Fox to privatize the monstrous oil company Pemex, and the electricity monopoly CFE, both of which have rich, eager customers only a few hundred miles to the north, is a shocking commentary on what the Latin American elite has been allowed to get away with. And this is in spite of bailout after bailout by the United States and the international banking system.

Reform in Latin America requires two things: a dismantling of the over-powerful state, so that resources are diverted from sticky government fingers towards the private sector, and a Thaksin/Mahathir style program of development of indigenous small business, funded by domestic middle-class savings. Both these needs will not only be unmet by further IMF bailouts of the local governments, they will be hindered.

The Washington Consensus may be irrelevant, as in Africa; partially effective, as in Asia, or largely damaging, as in Eastern Europe and Latin America.

In any case, it represents a state-oriented, top-down model of international economic development that has proved at best sub-optimal. To develop properly, countries need resources generated through and managed by the private sector: specifically, middle-class savings and small business. The Washington Consensus does nothing for these.

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Finally, the Washington Consensus fails because it is a single model, imposed by a monopoly public sector institution (or, more properly, by a cartel of such institutions, working together.)

To remedy this, the 1944 policy of the socialist John Maynard Keynes and the Marxist Harry Dexter White must be reversed. Economic development must be returned to the private sector, where it belongs, so that countries have a range of possible strategies to choose from, each sponsored by a different financial institution.

Doubtless in the future, such financing organizations will not all be primarily banks, nor will they predominantly originate in London. But they will, in essence, be reincarnations of those lost entities, whose absence will be increasingly mourned as the long world recession and financial bear market grinds on: the London merchant banks.


(The Bear's Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that, in the long 90s boom, the proportion of "sell" recommendations put out by Wall Street houses declined from 9 percent of all research reports to 1 percent and has only modestly rebounded since. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)

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