Washington Goodbye Consensus, Hello Washington Confusion? Dani Rodrik Melissa Prusock I. The Washington Consensus Washington Consensus (John Williamson 1990): policy proscription for economic reform in poor countries-stabilize, privatize, liberalize Reforms were unsuccessful: market oriented reforms did not produce growth in Latin America or Africa in the 1990s China, South Korea, Vietnam and India experienced growth and poverty reduction through unconventional policies-trade protection, no privatization, extensive industrial policies, lax fiscal and financial policies: they did not follow the Washington Consensus Washington Consensus is dead: what will replace it? II. World Bank's Learning from Reform (2005) There is no universal set of rules for economic reform in poor countries Emphasized need for humility, policy diversity, selective and modest reform, and experimentation Warns us to be skeptical of top-down, comprehensive, universal solutions-no matter how well intentioned they may be 1. Conventional reforms did not pay enough attention to stimulating the dynamic forces that lie behind the growth process. 2. The objectives of economic reform-market oriented incentives, macroeconomic stability, outward orientation-don't translate into a specific set of policy actions, ie. To achieve trade openness, can lower tariffs, but can also use duty drawbacks, export subsidies, special economic zones, export processing zones, etc. 3. Different contexts require different solutions to solving common problems. This is why countries that are growing have diverse policy configurations 4. Tendency in the 1990s to exaggerate the rules over discretion in government behavior-rules meant to discipline the malfeasance of governments but government discretion cannot be bypassed 5. Reforms need to be selective and focus on the binding constraints on economic growth rather than the laundry list approach of the Washington Consensus. Actors can figure out what the binding constraints are in each situation through common sense and analysis. Experimentation and learning about the nature of constraints are key to success III. IMF Report Washington has anything but a consensus The problem is not the approach to reform, it is that the reform did not go deep and far enough. This is because political leaders in poor countries lacked a commitment to reform and there was no institutional reform to enable the creation of a well functioning market economy. Should do the same thing, but do it well To implement the Washington Consensus, need sound institutions
Augmented Washington Consensus-"second generation" of reforms that focus on institutional reform, derives academic support from work on the primacy of institutions. However, literature has not established a strong causal link between any particular design feature of institutions and economic growth-what exactly makes investors feel secure? Little evidence that large scale institutional reforms play a role in economic growth Policy makers should target the most binding constraints to growth, not invest scarce political and administrative capital in ambitious institutional reformsreforms will be needed to sustain growth, but countries will be better off reforming institutions when the economy is already growing Focus on institutional reform leads to a policy agenda that is hopelessly ambitious and virtually impossible to fulfill IV. UN Millennium Project (2005) led by Jeffrey Sachs Advocates a comprehensive and simultaneous increase in "public investments, capacity building, domestic resource mobilization, and official development assistance while providing a framework for strengthening governance, promoting human rights, civil engaging society and promoting the private sector" Provides concrete details pf what can and should be done to accomplish this Based on the theory that low-income countries in Africa are stuck in low-level equilibrium (the poverty trap). It does not pay to invest, so households don't save, ergo the economy remains poor Raising capital stock will enable the economy to break free of the poverty trap Should significantly increase aid-double annual official development assistance However, historically few low-income countries have embarked on high growth as a result of the infusion of large amounts of aid Sub-Saharan African countries do experience growth-contrary to what the poverty trap says-but growth tends to fizzle out UN Project based on the view that we have enough knowledge to mount an ambitious, costly effort to eradicate world poverty whereas Learning from Reform says we should downplay grandiose claims, move cautiously, and concentrate efforts where payoffs seem greatest. V. Need a Practical Agenda for Growth Strategies 1. Diagnostic analysis to ascertain where the most significant constraints on economic growth are Economic activity constrained by at least 1 of 2 factors: a. The cost of finance is too high Symptoms-real interest rates high, borrowers chasing lenders, current account deficit as large as the foreign borrowing constraint will allow, entrepreneurs are full of investment ideas. Exogenous increase in investable funds, ie foreign aid and remittances, will spur primarily investment and other productive economic activities rather than consumption or investment in real estate
b. The private return on investment is low-this is due to either low economic (social) returns or a large gap in between social and private returns (low private appropriability) -Low social returns-due to poor human capital, lousy infrastructure, bad geography, etc -Appropriability problems-either policy/institutional environment (taxes too high, property rights protected poorly, high inflation may generate macro risk, labor-capital conflicts may depress production incentives) or market failures ie technological spillovers, coordination failures, problems of economic "self-discovery" (ie uncertainty about underlying cost structure of the economy) Symptoms-interest rates low, banks flush in liquidity, lenders chasing after borrowers, current account near balance or in surplus, entrepreneurs more interested I investing elsewhere than at home. Increase in foreign aid or remittances will finance consumption, housing, or capital flight 2. Creative and imaginative policy design to target said constraints-target the policy response as closely as possible on the source of the distortion Operating in a second-best environment due to distortions or administrative or political constraints. In designing policy must look for unforeseen complications and unexpected consequences. 3. Institutionalize the process of diagnosis and policy response to ensure the economy remains dynamic and growth doesn't fizzle out Two types of institutional reform needed over time a. Need to maintain productive dynamism, policy needs to ensure momentum of growth is maintained through diversification b. Strengthen domestic institutions of conflict management, endowing the economy with resilience against external shocks-ie terms of trade declines or reversals in capital flows-requires strengthening the rule of law, solidifying (or putting in place) democratic institutions, establishing participatory mechanisms, and erecting social safety nets What is required to sustain growth should not be confused with what is required to initiate growth Rodrik prefers Learning from Reform approach