'Washington consensus' needs revision

'Washington consensus' needs revision

By Grzegorz W. Kolodko

JAKARTA (JP): Ten years ago, when the post-communist
transition to a market economy and democracy begun, the so-called
"Washington consensus" was thought to represent the received
wisdom on the proper way to move from stabilization to growth.

According to this belief, a tough financial policy,
accompanied by deregulation and trade liberalization, would be
enough to eliminate stagnation and launch economic expansion. The
proposals for reform based on this reasoning were used to address
structural crises in various regions, despite the fact that they
had been developed mostly as solutions to problems in Latin
America. This orientation in policy reform had an important
impact on the course of the post-communist transition, too.

The policies of the Washington consensus were not drafted in
order to solve the crisis in post-communist countries entering a
period of transition toward a market economy.

The early consensus was actually aimed at distorted market
economies. For this reason, nations facing other challenges have
never found satisfactory answers to their most pressing questions
in the Washington-backed policy.

Its interpretation vis-a-vis the post-communist countries
suggests that it would be sufficient to liberalize prices and
trade and then fix the financial fundamentals, and -- of course
-- privatize the state assets. The faster and more of them, the
better. Subsequently, growth should occur and be sustainable.
Unfortunately, it has not been the case.

Such an approach has partially failed with respect to the
transition economies because it has neglected the significance of
institution building, even when the other fundamentals are by and
large in order.

This oversight explains why so many Western scholars did not
at first properly understand the true nature of the challenge.
Institutions can only be changed gradually, and they exert a very
strong influence on economic performance. It was quite naive to
expect robust economic growth so soon after the fundamentals (but
not the institutions) were in place. In fact, in the real world
of economic affairs, it is not possible to sustain fundamentals
if they are not backed by solid institutions.

Rapid growth was anticipated because it was assumed that
market institutions, if they did not appear out of thin air,
would rise up quite spontaneously the "day after" liberalization
and stabilization.

However, the "day after" liberalization and stabilization was
even more depressing than the "day before". Due to an absence of
planning and a systemic market vacuum, productive capacity was
being employed even less; savings and investment were declining,
and instead of rapid growth there was a sudden recession.

The lack of appropriate institutions turned out to be the key
element missing from the transition policies counseled by the
Washington consensus. Liberalization and privatization,
unsupported by well-organized market structures, generated not
sustained growth, but a lengthy period of contraction. This was
not an inherited problem; it was the result of poor policy.

Under some circumstances, the reasoning of the Washington
consensus may be relevant in dealing with the challenges faced by
distorted, less-developed market economies. However, in these
economies, market organizations have already been in place for
years. The post-communist economies possessed no basic market
organizations, since such organizations had not existed under the
centrally planned regime.

Therefore, because the absence of these organizations had
apparently gone unnoticed until after the beginning of the
transition, the market had no place to establish roots and grow.

This was the case especially if liberalization was rapid and
the privatization radical, but in other cases, too, there could
be no adequate and timely positive supply response. The
misallocation of resources and of investments merely continued,
although now for different reasons. This has been the main cause
of the great transitional depression lasting so long (even the
whole decade in Russia and Ukraine) in several post-communist
countries.

The economic policy orientation based upon neoliberal monetary
orthodoxy had a tremendous influence on the course of changes in
Eastern Europe and the former Soviet republics, as well as in the
Asian socialist economies. But from the results it appears as
though these nations did not all draw the same policy
conclusions.

A number of less-developed and transition economies quickly
realized that there could be no sustained growth without sound
institutional arrangements. Poland, in particular, was able to
move from ill-advised early "shock without therapy" to therapy
without shock between 1994 and 1997. During this period the
country's Gross Domestic Product grew by 28 percent under the
well-known "Strategy for Poland" program, in which the
implemented policy did not always follow International Monetary
Fund orthodoxy. An attempt to return to it after 1997 has slowed
down the growth again and caused growing social tensions.

Yet lessons are learned, and since the mid-1990s the IMF and
the World Bank have been paying more attention to the way market
structures are organized and to both the institutional and
behavioral aspects of market performance. Now they know that
liberalization and institutional organization are both required
for the market and economic growth. Because of the bitter
experience of transitional contractions it has become clear that
there will be no sustained growth unless the sound fundamentals
-- a balanced budget, balance in the current account, low
inflation, a stable currency, liberalized trade, and a vast
private sector -- are supported by appropriate institutions.
Indeed, they matter even more than stabilization.

There is now a consensus that the Washington consensus ought
to be reconsidered, revised, and adjusted to reflect the lessons
learned under real conditions. Both the Russian malaise and
Poland's success prove that such revision is necessary.

The writer, a key architect of Polish reforms, is a professor
at the Warsaw School of Economics and a Visiting Professor at
Rochester University, New York. He was First Deputy Premier and
Finance Minister in Poland from 1994 to 1997. From 1998 to 1999
he was a Visiting Fellow at the World Bank and the IMF. His new
book From Shock to Therapy. The Political Economy of
Postsocialist Transformation is forthcoming from Oxford
University Press. He recently delivered lectures at the
University of Indonesia in Jakarta and at Gadjah Mada University
in Yogyakarta.