The Washington Consensus cracks
Western economists are fighting among themselves as the world financial crisis bites. Andrew Marshall reports
Sunday 20 September 1998
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.
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