Beyond the Washington Consensus

Senior vice president and chief economist of the World Bank Joseph E. Stiglitz earlier this year delivered the 1998 United Nations University, World Institute for Development Research (UNU/WIDER) Annual Lecture titled "More Instruments and Broader Goals: Moving toward the Post-Washington Consensus," in Helsinki. We have excerpted some major ideas from the presentation, which is available in full on the following website: http://www.wider.unu.edu/stiglitx.htm

The policies advanced by the Washington Consensus are not complete, and they are sometimes misguided. Making markets work requires more than just low inflation, it requires sound financial regulation, competition policy, and policies to facilitate the transfer of technology and encourage transparency. These are some of the fundamental issues neglected by the Washington Consensus. Our understanding of the instruments needed to promote well-functioning markets has improved, and we have broadened the objectives of development to include other goals, such as sustainable, egalitarian, and democratic development.

The success of the Washington Consensus as an intellectual doctrine rests on its simplicity. Its policy recommendations could be administered by economists using little more than simple accounting frameworks. A few economic indicators— inflation, money supply growth, interest rates, and budget and trade deficits—could serve as the basis for creating a set of policy recommendations. Indeed, in some cases economists would visit a country, look at and attempt to verify these data, and make macroeconomic recommendations for policy reforms all within a couple of weeks.

Probably the most important policy prescription of the stabilization packages promoted by the Washington Consensus was controlling inflation. The evidence, however, has shown only that high inflation is costly. Recent research suggests that low levels of inflation may even improve economic performance relative to what it would have been with zero inflation.

A second component of macroeconomic stability has been reducing the budget deficit and the current account deficit. There is, however, no simple formula for determining the optimum level of the budget deficit or the current account deficit. For instance, the case for maintaining budget surpluses in the East Asian countries in the face of an economic downturn, where the rate of private saving is high and the public debt-GDP ratios are relatively low, is less compelling.

Macroeconomic stability—as conceived by the Washington Consensus—downplays the stabilization of output or unemployment. Minimizing or avoiding major economic contractions should be one of the most important goals of policy. In the short run large-scale involuntary unemployment is clearly inefficient - in purely economic terms it represents idle resources that could be used more productively. The social and economic costs of these downturns can be devastating: lives and families are disrupted, poverty increases, living standards decline, and, in the worst cases, social and economic costs translate into political and social turmoil.

The importance of building robust financial systems goes beyond simply averting economic crises. The financial system can be likened to the "brain" of the economy. It plays an important role in collecting and aggregating savings from agents who have excess resources today. These resources are allocated to others—such as entrepreneurs and home builders—who can make productive use of them. The financial system must continue to monitor the use of funds, ensuring that they continue to be used productively. In the process financial markets serve a number of other functions, including reducing risk, increasing liquidity, and conveying information.

Left to themselves, financial systems will not do a very good job of performing these functions. There is a growing recognition of the importance of sound legal framework, sound institutions, and good information for the effective functioning of markets. But the agenda for creating sound financial markets should not confuse means with ends; redesigning the regulatory system, not financial liberalization, should be the issue.

The fundamental theorems of welfare economics, the results that establish the efficiency of a market economy, assume that both private property and competitive markets exist in the economy. Many countries—especially developing and transition economies—lack both. Until recently, however, emphasis was placed almost exclusively on creating private property and liberalizing trade—trade liberalization being confused with establishing competitive markets. Trade liberalization and privatization are important, but we are unlikely to realize their full benefits without anti-trust laws and enforcement and other policies to increase competition.

Chinese policymakers not only eschewed a strategy of outright privatization, they also failed to incorporate numerous other elements of the Washington Consensus. Yet China’s recent experience is one of the greatest economic success stories in history. One of the important lessons of the contrast between China and Russia is for the political economy of privatization and competition.

It has proved difficult to prevent corruption and other problems in privatizing monopolies. The huge rents created by privatization will encourage entrepreneurs to try to secure privatized enterprises rather than invest in creating their own firms. In contrast, competition policy often undermines rents and creates incentives for wealth creation. The sequencing of privatization and regulation is also very important. Privatizing a monopoly can create a powerful entrenched interest that undermines the possibility of regulation or competition in the future.

The Washington Consensus policies were based on a rejection of the state’s activist role and the promotion of a minimalist, noninterventionist state. The unspoken premise is that governments are worse than markets. Therefore, the smaller the state the better the state. It is true that states are often involved in too many things, in an unfocused manner. Trying to get government better focused on the fundamentals—economic policies, basic education, health, roads, law and order, environmental protection—is a vital step. But states can also improve their capabilities by reinvigorating their institutions. This means not only building administrative or technical capacity but instituting rules and norms that provide officials with incentives to act in the collective interest while restraining arbitrary action and corruption. Perhaps some of the most promising and least explored ways to improve the function of government is to use markets and market-like mechanisms.

The Washington Consensus advocated the use of a small set of instruments (including macroeconomic stability, liberalized trade, and privatization) to achieve a relatively narrow goal: economic growth. The post-Washington Consensus recognizes that a broader set of instruments is necessary and that our goals are also much broader. We seek increases in living standards—including improved health and education—not just increases in measured GDP. We seek sustainable development, which includes preserving natural resources and maintaining a healthy environment. We seek equitable development, which ensures that all groups in society, not just those at the top, enjoy the fruits of development. And we seek democratic development, in which citizens participate in a variety of ways in making the decisions that affect their lives.

Whatever the new consensus is, it cannot be based on Washington. If policies are to be sustainable, developing (and transition) countries must claim ownership of them. A second principle of the emerging consensus is that a greater degree of humility is called for, acknowledgement of the fact that we do not have all the answers. Continued research and discussion, not just between the World Bank and the International Monetary Fund, but throughout the world, is essential if we are to better understand how to achieve our many goals.

Hard copies of the paper (WIDER Annual Lectures 2) are available free at UNU/WIDER Publications, Katajanokanlaituri 6 B 00160 Helsinki, Finland. tel. 358-9-615-9911, fax 358-9-615-99333, Email: wider@wider.unu.edu .