Beyond the Washington consensus
By Bharat Jhunjhunwala
NEW DELHI (JP): World Bank Chief Economist Joseph Stiglitz has called for a post-Washington consensus.
The origins of the original consensus lie in the crisis of the 1980s. Most Latin American countries were then suffering hyperinflation. Banks borrowed heavily from Western banks to fund luxury projects and to support loss-making state enterprises. The money vanished but the debt remained.
Amid this backdrop, U.S. government officials, the International Monetary Fund (IMF) and the World Bank came up with the "Washington Consensus". They called on developing countries to restrain domestic expenditures and restore macroeconomic stability.
Such prudence, it was thought, would curb government profligacy, create confidence among global investors, attract foreign investment and enable exports and economic growth to pick up.
Now Stiglitz has asserted that the approach was faulty.
Macroeconomic stability, instead of promoting foreign investment, may have actually hurt it. Cuts in government expenditure led to a contraction of domestic output, which in turn curtailed domestic demand and discouraged foreign investment.
Stiglitz asserts that as a result of the consensus, a sudden influx of cheap imports pushed domestic firms to the brink rather than helping multinational competition.
Stiglitz says globalization along with increased government spending will lift the countries from their doldrums. The proposition ignores the fact that the crisis-ridden countries have experienced not only a shrinking domestic market but also reduced exports.
The Washington consensus should not be blamed for this state of affairs. The finger should be pointed instead at the deepening recession in industrial countries. No amount of tinkering with domestic policies will do any good unless this basic anomaly of globalization is confronted.
Stiglitz advocates that excessive concern with macroeconomic stability is an incorrect approach. He argues that incurring a fiscal deficit for infrastructure investment, such as roads, is entirely legitimate.
Inflation rates of up to 40 percent per year are now acceptable. Restrictions on a sudden influx of imports, which may have a devastating effect on local enterprises, is also justifiable. Controls on capital inflows, particularly short term ones are desirable.
His arguments imply that the process of globalization -- export and foreign investment-based growth strategies -- is in itself sound. Industrial countries will continue to provide a market for exports and also the capital to produce them.
According to Stiglitz, the problem lies in the developing countries fine-tuning their policies. Latin American countries are considered to be wildly extravagant spenders. At the other end of the spectrum, Asian countries abruptly halted many business activities. If developing countries could get their policies right, then globalization benefits would come their way.
Admission of errors is welcome, however, they do not explain why export and direct foreign investment-led growth faltered in the Asian countries. Exports should have picked up as domestic government expenditures contracted. Collapse of the Asian currencies has made their exports more competitive.
The development should have led to greater export earnings. The process should have attracted more foreign direct investment (FDI), not less. The real value of foreign investment in domestic currencies would be greater than before. Why then do we find that exports from these countries are declining and likewise FDI inflows?
The answer is provided by the United Nations Conference on Trade and Development. "Neither a return to stability in the buffeted Asian economies, nor the apparent containment of the Brazilian crisis can hide the downside risks facing the global economy in 1999" concludes its recent report on Global Economic Conditions and Prospects. Drawing on predictions made by the IMF, the World Bank, the Organization for Economic Cooperation and Development (OECD), the United Nations and J.P. Morgan, it predicts that the growth rate in all industrial economies -- Japan, the European Union and the United States -- will fall in 1999.
The collapse in the industrial economies explains the fate of the Asian tigers, not their contractionary domestic policies, as suggested by Stiglitz. It was presumed that the demand from industrial countries would remain buoyant forever and ever.
It has now dawned on pundits that, rather than concentrating on exports, domestic demands should fuel the engine of globalization. This is an admission of great consequence.
The two components of globalization were exports and foreign investment. Foreign investment, it was thought, would bring in the capital and technology and export the goods produced. Its role in the domestic economy would be additional, not competitive. With an export collapse, the logic of foreign investment will need to be reinvestigated; foreign investors must now compete with domestic investors.
Stiglitz' call for a post-Washington consensus, therefore, is an implicit admission that the sun is setting on globalization. The demand from industrial countries is declining. Free trade is no longer the impetus of growth.
Since the East Asian crisis erupted, many explanations have come from the West. First, it was blamed on a lack of transparency in the financial markets. Then it was alleged that the problem was excessive short term borrowing. Next came criticism of "hot money" -- portfolio investments.
Now Stiglitz says that excessive concern with the fiscal deficit was misplaced. It is interesting that none of these pundits cared to even mention the downturn in industrial countries as even a remote reason for the crisis.
Stiglitz has correctly pointed out that domestic expansion, including fiscal deficit increase, are sound policies for the developing world today.
But he is unwilling to let go of foreign investment as a key strategy. Instead of waiting for this truth to dawn on Western pundits, the developing countries must consider reverting back to domestic demand and domestic capital-based growth strategies.
The writer, a graduate from the University of Florida, is a lecturer at the Indian Institute of Management.