The Washington Consensus: Steps to build an economy?

Imagine being in charge of a country which has undergone a rapid change for the worse in terms of an economic standpoint. It is definitely difficult to get the country back on track. Because of the help of the IMF and the World Bank you can now start afresh. However, it is still confusing about what has to be done to build your economy from scratch. Thankfully there are a set of rules to help you in this endeavor in setting up a self-sufficient economy known as the Washington Consensus. So let us find out what it is and how it functions.

What is the Washington Consensus?

John Williamson, an economist, first used the term “Washington Consensus” in 1989. He was discussing a set of measures that had gained acceptance among Latin American politicians in reaction to the early to mid-1980s macroeconomic unrest and debt crisis. In order to aid in the recovery from the debt crisis, these measures were also supported by specialists in Washington’s international institutions, particularly the International Monetary Fund and the World Bank as well as the US Treasury.

A note of caution, these rules are only meant to be descriptive and not prescriptive, which means that these rules do not guarantee the economy to be a success. Definitely there will have to be some considerations taken in place depending on the scenario of the country and what can actually be done depending on the ability of the government.

Maintaining fiscal restraint, reallocating public spending priorities (from subsidies to health and education spending), reforming tax law, letting the market determine interest rates, upholding a competitive exchange rate, liberalising trade, allowing inward foreign investment, privatising state enterprises, removing barriers to entry and exit, and protecting property rights are among the main Washington Consensus policies. Williamson pointed out that these policies went against what was believed to be true in developing nations, many of which adopted state-dominated systems in the 1950s.

The 10 rules of the Washington Consensus

  • Reduce national budget deficits

Large budget deficits lead to high variable tax rates. To counteract this, it was suggested to observe fiscal discipline either by raising tax revenues or by reducing domestic spending to reduce the amount of spending done by the government.

  • Redirect spending from politically popular areas toward neglected fields with high economic returns

Some aspects of public spending, such as subsidies to state-owned businesses or for the purchase of food or fuel, caused economic distortions and favored wealthier urban people over the impoverished in rural areas. Reducing subsidies for politically connected economic sectors may cost some people money, but it frees up funds for expenditure on infrastructure, education, and fundamental social services.

  • Reform the tax system

Reforms should enlarge the tax base and eliminate the exclusions that exempt some people and organizations with political ties from paying taxes. Taxation that is more inclusive and straightforward can boost productivity, increase tax revenue, and lessen tax evasion.

  • Liberalize the financial sector with the goal of market-determined interest rates

Government interest rate regulations typically penalize savers, deter investment, and stifle financial progress; restricting credit typically encourages corruption and benefits political insiders. Market-based interest rates encourage saving and ensuring that banks or the financial sector, not politicians in the government, decide how much credit is given out.

  • Adopt a competitive single exchange rate

A competitive, market-driven exchange rate can encourage export-led economic growth and alleviate balance of payments issues; avoid inflated exchange rates that deter exports and cause currency rationing.

  • Reduce trade restrictions

Trade barriers that support particular interests should be eased generally. Tariffs are better to quotas and other arbitrary trade restrictions that stifle trade since they allow for progressive reduction, local enterprises to adapt, and produce money for the government as opposed to quota rents for special interests.

  • Abolish barriers to foreign direct investment

Foreign investment that is prohibited or restricted at home gives monopolies to native companies and lessens competition. A country can increase its capital, create jobs, and develop its workforce through foreign investment, but also increasing competition for native businesses. Domestic businesses that attract FDI can encourage intellectual property breakthroughs that advance development.

  • Privatize state-owned enterprises

State-owned businesses frequently operate inefficiently and rely on subsidies from the government, which increase countries’ fiscal deficits. While some unemployment may result from privatization, these changes are more likely to boost firm productivity and profitability.

  • Abolish policies that restrict competition

Removing regulations and obstacles that prevent new firms from entering the marketplace can stimulate competition, efficiency, and economic growth.

  • Provide secure, affordable property rights

Investment and individual liberty are encouraged by a legal system that awards and preserves property rights, including the rights of those who hold land without legal documentation and work undocumented jobs in the informal sector. Owners can obtain financing thanks to private assets, which grows the economy and the revenue base of the government.

Effects of the Washington Consensus

By the middle of the 1990s, the benefits had mainly fallen short of expectations, especially in Latin America, where reforms had been pursued with particular zeal. The Washington Consensus was expanded to prescribe a longer list of adjustments in response, which is evident in the increasing number of terms and conditions associated with IMF and World Bank loans.

However, sluggish development, recurrent fiscal crises, and widening inequality cast doubt on the success of the entire project, severely harming the Washington Consensus’ political reputation. A new wave of leftist governments appeared in Latin America in the 2000s, many of which ran on platforms promising to reverse these regulations.

Major Criticisms

  1. Free trade is not necessarily advantageous for emerging economies, according to some economists. To ensure long-term prosperity, several strategic and young industries must first be preserved. These businesses can also need protection from imports in the form of subsidies or taxes.
  2. Government assistance has allowed Chinese businesses to make significant investments in Asia, Latin America, and Africa’s developing nations. These businesses frequently make infrastructural investments, opening doors for long-term trade and growth.
  3. Privatization can boost output and raise the standard of the good or service. Privatization, however, frequently causes businesses to disregard specific low-income segments or the social demands of a rising economy.

Conclusion

There can never be a fixed set of rules that even by theory can help to build a self-sufficient economy, the short-term impacts of these rules did not help the targeted economies, however it helped them build a strong base on which these economies can stay stable and thus helped the long-term growth of these economies. Any sets of rules can only be descriptive and not prescriptive for an economy, as each economy in itself is unique and all require different solutions for them to get through their problems. Sure, these rules could be taken as an outline, but definitely not the guidebook to build an economy.

Abishek Jeremy Lobo

Editor, TJEF

References

  1. https://www.piie.com/blogs/realtime-economic-issues-watch/what-washington-consensus
  2. https://www.piie.com/commentary/speeches-papers/washington-consensus-policy-prescription-development
  3. https://www.washingtonpost.com/politics/2021/04/16/people-have-long-predicted-collapse-washington-consensus-it-keeps-reappearing-under-new-guises/
  4. https://www.intelligenteconomist.com/washington-consensus/