Rethinking Economic Policy: The Washington Consensus Turns to Custard

Listener 3 July, 1999.

Keywords: Growth & Innovation;

Half a decade ago, capitalism appeared to have triumphed over communism (if one is allowed the crudity of these descriptors). When the Berlin Wall fell in 1989, the Eastern European nations of the COMECON pact left the Soviet fold, looking to the West as they transformed their economies and ways of political life. The rest of the Russian Empire broke up in 1993, and they went west too. No longer is a “spectre … haunting Europe – the spectre of communism” (as Karl Marx wrote in 1848).

The path these transition economies took is popularly captured by what is known as the “Washington Consensus”, although some countries were less enthusiastic than others. The city of Washington is the home of the International Monetary Fund, the World Bank, and the US Treasury, although the articulation of the ten key notions occurred at a think-tank conference held in that city in 1990. They are summarised as
– fiscal discipline;
– public expenditure priorities in health and education;
– tax reforms;
– positive but moderate market determined interest rates;
– competitive exchange rate;
– liberal trade policies;
– openness to foreign direct investment;
– privatisation;
– deregulation;
– protection of private property right.

Broadly they represent the direction of New Zealand economic policy in the last 15 years (although we often took a more extreme stance). The policies were not only seized upon by the transition economies, but also by the Western and Asian capitalists, enthusiastically greedy for the profitable opportunities they offered.

The transitions were always going to be difficult, but there was an alternative to the Washington Consensus, which has led to a far more successful economic performance. If Marx’s spectre no longer haunts Europe, China has continued along its own distinctive cautious liberalisation towards a more market, more capitalist economy (with continued political control). While the Russian Gross Domestic Product has fallen by about half since 1989, the Chinese GDP has more than doubled. By being more selective in its response to liberalisation than the Russians, the Chinese economy seems to be succeeding.

So the Washington Consensus is crumbling, if not already turning to custard. Leading the charge has been the World Bank, with the Fund and the US Treasury more reluctantly following. The chief critic is Joe Stiglitz, senior vice-president and chief economist of the Bank, a fine economist whose theoretical contributions are likely to receive a “Nobel Prize” in economics (deservedly, unlike some others so awarded). His criticism is summarised by “the failures of the reforms … go far deeper – to a misunderstanding of the very foundations of a market economy, as well as a failure to grasp the fundamentals of the reform processes. … at least part of the problem was an excessive reliance on textbook models of economics.” Later he says “the Washington Consensus doctrines of transition failed in their understandings of the core elements of a market economy”. At the heart of Stiglitz’s critique is that there has been the neglect of the social institutions which underpin an economy. Of the ten key policies, only the one about property rights mentions them.

In his paper to the Bank’s annual conference on development economics in April, Stiglitz is scathing about the “shock therapy” approach (he also calls it “blitzkrieg”) to the reforms. He argues for “continuous change – trying to preserve social capital that cannot be easily reconstructed.” Attitudes towards the recent reforms, he says, were like those of the bolsheviks (yes, he acknowledges the irony) who were intent on destroying the social institutions of the Russia they took over in 1918. But the Chinese seem to have learned from the failures of the Great Leap Forward and the Cultural Revolution. “They chose the path of incrementalism (`crossing the river by groping for the stones at one at a time’) and non-ideological pragmatism (`the question is not whether the cat is black or white, but whether or not it catches the mice’). They had the wisdom to `know they didn’t know what they were doing’ so they didn’t jump of the cliff after being assured by experts that they would be jumping over the chasm in just one more great leap forward.”

While Stiglitz seems unaware of the New Zealand experience (he visited here in 1968), the relevance of his analysis to the New Zealand experience is extraordinary. My book, The Commercialisation of New Zealand, argues along very similar lines, and its successor, The Whimpering of the State: Policy after MMP, due out this month, provides much detail about the way that social institutions have been damaged by our reforms.

Stiglitz, and his associates, are not arguing for an anti-market stance. His theoretical works (and textbook) show a tremendous respect for (and insight to) the power of the market system, and he would certainly support an open economy based on private property. But his account also recognizes the importance of society, with the government playing a positive role. His paper ends with “The [transition] countries – and their advisors – will have learned from the many bitter and disappointing failures – and the few successes – of the past decade.” Thoughtful New Zealanders will say “Amen”.