The Washington Consensus cracks

Western economists are fighting among themselves as the world financial crisis bites. Andrew Marshall reports

LORD HOWE held most of the great offices of state in Britain, presiding over many of the most controversial departures which took place under Margaret Thatcher. Yet he confided to a senior official once that he had only ever had one sleepless night over policy. It came in 1979, when the Government abandoned exchange controls. What would happen, he worried, if it caused a collapse of confidence in the markets? What would happen if Britons and foreign investors alike took it as the opportunity to shift their cash en masse abroad? Denis Healey called it a "reckless, precipitate and doctrinaire step" to dismantle controls that had been erected largely in the 1930s as the world economy teetered.

It was in many respects one of the boldest adventures in British economic policy, and helped set the pattern of events for the world over the years that followed. Under Thatcher and Ronald Reagan, Britain and America were wedded in the pursuit of free markets, liberalised capital flows and a global economy.

Their successors have not only never questioned those orthodoxies: they have taken them to every corner of the globe, encouraging countries which had only just peeked out from behind the Iron Curtain, or were emerging slowly into the capitalist world from under-development. They became, after the Latin American debt crisis of the 1980s, the only policy prescription on offer, the remedy that was stamped with the approval of the US government, the International Monetary Fund and the World Bank as the "Washington Consensus".

Yet now, the wind is blowing in the other direction after the implosion of the Asian tigers and the collapse of Russian reform efforts. After two decades when the Anglo-Saxon economic policy prescription has been in the ascendant, with nothing to touch it, attitudes have changed, with Malaysia re-imposing currency controls, and Hong Kong intervening in the stock market and acting to prevent currency speculation. A senior Hong Kong official in Washington to discuss the move, Andrew Sheng, was characteristically understated. "There is now a healthy debate," he said, "about whether the Washington Consensus will really work."

That debate has put economists, international organisations and governments at each others' throats, and on its outcome hangs the fate of many nations and the international economic order itself.

The key proponents of the Washington Consensus are Larry Summers - the brilliant young economist who serves as deputy secretary of the US Treasury - and Stanley Fischer, a Rhodesian-born economist who left MIT at the same time that Mr Summers left Harvard to become number two at the International Monetary Fund. They have spearheaded the Washington Consensus in good times and bad, and in particular have led the efforts to tackle the complicated crises that have struck half the world in the last year.

When crises hit, the recipe from the West was broadly the same everywhere: cash from the IMF but on condition of tougher monetary policy, spending cuts, more open markets and an end to crony capitalism. It was nasty medicine, and often politically painful.

It also drew fire from the economic establishment in America. Jeffrey Sachs was, with Mr Summers, the youngest ever to receive tenure from Harvard: they got their posts on the same day in 1983 and studied together as graduates. But Mr Sachs, back at Harvard after giving economic advice to countries around the world, thinks Mr Summers and Mr Fischer botched the recovery of Asia. The packages were too tight, too uniform, too penalising.

What Asia needed was time and more money, he has argued. And on one occasion in Cambridge this March, he argued it with Mr Fischer present, at a seminar chaired by Paul Krugman, another in the Sachs-Summers generation of economists. Mr Fischer lost his temper, according to reports. That may partly be because he feels that a group of his younger colleagues are ganging up on him: both Mr Krugman and Jagdash Bhagwati, another talented young trade economist, have suggested that capital controls have a role to play in the management of short-term capital crises.

And across the road from Mr Fischer at the World Bank, Joseph Stiglitz, its chief economist, also argues: "There is little, if any, evidence that liberalising a country's capital account leads to higher growth." The issue has come to symbolise the policy divide that has opened up within the Washington Consensus.

The expansion of capital flows would, it has been believed for decades, promote both free trade and political stability. Now, it seems to be working against those aims.

In particular, the economists believe that some measure of unorthodoxy on capital flows may be necessary to save free trade, which is regarded as a higher-order aim, from a global backlash.

The policy establishment also wants to secure the political stability of Russia, but it is watching it disintegrate politically as well as economically. The risks of a backlash are incalculable, but there is no agreement on what to do instead.

With increasing criticism from outside and inside, it is hardly surprising that Mr Summers is on the defensive. His allies point out that he is under fire from many directions at the same time: from the Wall Street Journal, which calls him "Bail-out Larry" and blames him for helping to promote hand-outs to countries that don't deserve them; and from the political left, which accuses him of penalising developing countries in the service of Wall Street.

He is not a doctrinaire free-marketeer and is far from agreeing with the IMF on every policy. But he is also trying to persuade a sceptical Congress that the IMF needs more money. The IMF itself is hamstrung by the fact that America and Europe can't agree on what to do next.

While the Consensus twists in the wind, things are changing rapidly in the real world outside. After Asia and Russia, Brazil is the next test case. Brazil, so long one of the bad boys in the Latin American debtors club, has been making outstanding progress by the standards of the IMF, and it will be loath to see a star pupil go down the pan. It is possible that the IMF will mobilise new funds, but other steps, too, will be needed. There may even be a case for the Brazilians to adopt capital controls, some in Washington believe, to stop the exodus of cash. The reimposition of capital controls would be a sea change, not because the measures introduced were in themselves that drastic, or even because the absence of capital controls is at the heart of the model: it isn't. But they have a symbolism, as Lord Howe's fear at the time - and subsequent pride in his achievement - demonstrated.

Under the old Bretton Woods system, capital controls were acceptable as a stabilising measure to buttress fixed exchange rates and free trade: there had to be safety valves somewhere. That was all blown away in the 1970s as intellectual attention shifted to the benefits of capital flows. Since then, the massive expansion of direct and portfolio investment has spearheaded the vast economic shift towards globalism.

But was it really so smart to ask countries that were still blinking in the daylight to take measures which took Britain over three decades to tackle after the Second World War?

Capital controls are being reapplied because governments have come to fear that the rapid ebb and flow of short-term capital - a wave that they had ridden to prosperity, in many cases - would wash them away. As most economists point out, they are rarely very effective, but in some cases, as Messrs Krugman, Sachs and Bhagwati point out, they may be the best second-best that there is. They may work badly but, as Mr Krugman asks: "When you face the kind of disaster now occurring in Asia, the question has to be: badly compared with what?"

When Malaysia slapped them on again, it was the first decisive step backwards for the hegemony of economic globalism. It came in a country that had been considered a standard bearer for the Consensus. And it is forcing Washington to confront the possibility of a policy defeat on a broader scale, as other nations either step off the road or never take it up at all. The crunch will come at this year's annual IMF meeting on 6 October, when bankers, central bankers, economists and finance ministers come together to pat each other on the back.

This year, they will all be much more wary: and as they approach the backs of their colleagues, some will be carrying knives.

News
In 2006, Pluto was reclassified as a 'dwarf planet'
scienceBut will it be reinstated?
News
Jennifer Lawrence at the Vanity Fair Academy Awards party in February 2014
people12 undisclosed female victims are seeking $100m in damages
Arts and Entertainment
Adam Levine plays a butcher who obsessively stalks a woman in Maroon 5's 'Animals' music video
music'Animals' video 'promotes sexual violence against women'
News
people Biographer says cinema’s enduring sex symbol led a secret troubled life
PROMOTED VIDEO
Voices
voicesI like surprises - that's why I'm bringing them back to politics, writes Nigel Farage
News
Bear and hare woodland scene from John Lewis Christmas advert
newsRetailer breaks with tradition, selling real festive fir trees online for the first time
Arts and Entertainment
Anthony Horowitz will write the next 007 novel
booksAnthony Horowitz to write new instalment in spy series for 2015
News
British actor Idris Elba is also a DJ and rapper who played Ibiza last summer
people
News
people

Kirstie Allsopp has waded into the female fertility debate again

Sport
Kicking on: Nathaniel Clyne is relishing the challenge of the Premier League after moving from Crystal Palace
footballSurprises include a first ever call-up for one Southampton star
News
ebooksAn unforgettable anthology of contemporary reportage
Voices
4 May 2013: The sun rises over Tower Bridge in London. Temperatures across the UK could be higher than several European holiday destinations by Monday, including parts of Italy and France (Andy Hepburn/PA)
voices
News
The moon observed in visible light, topography and the GRAIL gravity gradients
science

...and it wasn't caused by an asteroid crash, as first thought

News
Researchers say a diet of fatty foods could impede smell abilities
scienceMeasuring the sense may predict a person's lifespan
News
newsGlobal index has ranked the quality of life for OAPs - but the UK didn't even make it into the top 10
Extras
indybest
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Trainee Recruitment Consultant - Birmingham - Real Staffing

£18000 - £23000 per annum + Commission: SThree: Real Staffing are currently lo...

Trust Accountant - Kent

NEGOTIABLE: Austen Lloyd: TRUST ACCOUNTANT - KENTIf you are a Chartered Accou...

Graduate Recruitment Consultant - 2013/14 Grads - No Exp Needed

£18000 - £20000 per annum + OTE £30000: SThree: SThree are a global FTSE 250 b...

Law Costs

Highly Competitive Salary: Austen Lloyd: CITY - Law Costs Draftsperson - NICHE...

Day In a Page

Italian couples fake UK divorce scam on an ‘industrial scale’

Welcome to Maidenhead, the divorce capital of... Italy

A look at the the legal tourists who exploited our liberal dissolution rules
Tom and Jerry cartoons now carry a 'racial prejudice' warning on Amazon

Tom and Jerry cartoons now carry a 'racial prejudice' warning on Amazon

The vintage series has often been criticised for racial stereotyping
An app for the amorous: Could Good2Go end disputes about sexual consent - without being a passion-killer?

An app for the amorous

Could Good2Go end disputes about sexual consent - without being a passion-killer?
Llansanffraid is now Llansantffraid. Welsh town changes its name, but can you spot the difference?

Llansanffraid is now Llansantffraid

Welsh town changes its name, but can you spot the difference?
Charlotte Riley: At the peak of her powers

Charlotte Riley: At the peak of her powers

After a few early missteps with Chekhov, her acting career has taken her to Hollywood. Next up is a role in the BBC’s gangster drama ‘Peaky Blinders’
She's having a laugh: Britain's female comedians have never had it so good

She's having a laugh

Britain's female comedians have never had it so good, says stand-up Natalie Haynes
Sistine Chapel to ‘sing’ with new LED lights designed to bring Michelangelo’s masterpiece out of the shadows

Let there be light

Sistine Chapel to ‘sing’ with new LEDs designed to bring Michelangelo’s masterpiece out of the shadows
Great British Bake Off, semi-final, review: Richard remains the baker to beat

Tensions rise in Bake Off's pastry week

Richard remains the baker to beat as Chetna begins to flake
Paris Fashion Week, spring/summer 2015: Time travel fashion at Louis Vuitton in Paris

A look to the future

It's time travel fashion at Louis Vuitton in Paris
The 10 best bedspreads

The 10 best bedspreads

Before you up the tog count on your duvet, add an extra layer and a room-changing piece to your bed this autumn
Arsenal vs Galatasaray: Five things we learnt from the Emirates

Arsenal vs Galatasaray

Five things we learnt from the Gunners' Champions League victory at the Emirates
Stuart Lancaster’s long-term deal makes sense – a rarity for a decision taken by the RFU

Lancaster’s long-term deal makes sense – a rarity for a decision taken by the RFU

This deal gives England a head-start to prepare for 2019 World Cup, says Chris Hewett
Ebola outbreak: The children orphaned by the virus – then rejected by surviving relatives over fear of infection

The children orphaned by Ebola...

... then rejected by surviving relatives over fear of infection
Pride: Are censors pandering to homophobia?

Are censors pandering to homophobia?

US film censors have ruled 'Pride' unfit for under-16s, though it contains no sex or violence
The magic of roundabouts

Lords of the rings

Just who are the Roundabout Appreciation Society?