Economics

Washington Consensus: Reforming or Ruinous?

Washington Consensus

‘Markets can handle everything!’ Well, it’s not me who’s saying this, but the Washington Consensus. The developing economies were facing a crisis during the 1980s, and Latin American economies in particular. And who was responsible to dictate the terms and get them out of this crisis? The United States of America! So, the United States Department of Treasury, together with international institutions like the International Monetary Fund and the World Bank suggested a set of policy reforms or ‘prescriptions’ to these developing nations. This is called the Washington Consensus as all these institutions are headquartered in Washington. To which economic system was these policies inclined to, market or non-market? Did these policies really work for the developing nations? What were its criticisms? We’re gonna answer all these questions in this blog.

Washington Consensus
Image by- IAS Gyan

Washington Consensus

Historical Background: The debt crisis

The major developing economies were going through a debt crisis during the period, particularly the Latin-American countries like Argentina, Mexico, Brazil, etc. They borrowed a large amount of capital from the international creditors, basically for the purpose of infrastructure development and industrialization. Due to the oil price increase from 1973-1980, oil-rich countries were flushed with excessive liquidity, and these countries invested this excess capital in these developing economies through the World Bank. The creditors around the world provided these economies with the funds without any hesitation. Well, who’d hesitate to provide developmental loans to a country with a GDP growth rate of 7.1% (GDP growth of Argentina in 1979)? And this continued decisively and confidently, however, this confidence was nothing but complacency.

Washington Consensus
Image by- Prezi

It didn’t take much time for Argentina’s GDP growth rate to fall from 7.1% to 0.7%  (Argentina’s GDP growth was just 0.7% in 1980). And the conditions of other Latin American economies were the same.  Around the 1980s, most of these countries were economically deteriorated and were not in a position to repay these loans, getting into a debt trap. In 1982, Mexico openly declared that it was now unable to pay back the international debt and requested an extension in the payments period. Other debt-ridden countries followed the suit. The commercial banks now significantly reduced and even halted fresh loans to Latin American economies.

Image by- Sciences Po

However, they had to find a way out of this crisis and prevent further stagnation of their economies, ultimately, they had to do something to survive. And this survival wasn’t possible without fresh loans. But from where? The Western and Japanese commercial banks, which were more than happy to lend these economies, were now reluctant enough to even halt the fresh loans!

Then came the International Monetary Fund (IMF) to help them out. However, this intervention by the IMF wasn’t unconditional. The IMF laid out strict conditions for providing them loans and give them a breather.

Washington Consensus
Image by- Business Insider
The Responsibility

The IMF did give a breather to these economies in the form of emergency loans. However, there was a need for long-term policy measures that would enhance the fundamentals of these economies, rather than these short-term measures to provide them with more loans.

So, the developing western economies, particularly the USA, together with the World Bank and International Monetary Fund took the responsibility to help these debt-ridden economies through a set of policy recommendations, which would, according to them, be beneficial to all the developing economies.

So, the IMF, World Bank, and the U.S. Department of the Treasury together came up with ten-point economic policy recommendations for the developing economies, Latin American in particular, which is referred to as the Washington Consensus. 

  1. Fiscal Discipline: Discipline in the Fiscal Policy of the developing nations by avoiding large fiscal deficits.
  2. Redirection of public expenditure priorities: To redirect the public spending policies towards those fields which would provide higher economic growth and welfare for the poor like education, healthcare, and infrastructure. And also eliminate the irrational subsidies.
  3. Tax reforms: Lowering the marginal tax rates and expand the overall tax base.
  4. Liberalization of interest rates: Let the market forces determine the interest rates rather than a regulator.
  5. Competitive exchange rates
  6. Trade Liberalization: Liberalizing the trade by eliminating certain tariff and non-tariff barriers, even if trade protection is to be provided, the protective tariffs should be low and uniform.
  7. Liberalizing FDI(Foreign direct investments) inflows: Allowing the FDI’s from investors around the world.
  8. Privatization: Privatizing the state-owned enterprises, especially those which are dwelling in losses.
  9. Deregulation: Eliminating the regulations imposed on the markets and businesses which tend to disrupt the smooth functioning of the businesses, except for some regulations which are meant for environmental and consumer protection.
  10. Securing Property Rights 

The policy of fiscal discipline was meant to reduce inflation in the economies, which already suffered hyperinflation during the debt crisis. The policy advised the nations to reduce inflation by increasing the interest rates and avoiding high fiscal deficits.

The policies of liberalizing interest rates, trade, foreign investments were meant to integrate them into the globalized economy.

Policies of privatization, deregulation, tax reforms, and securing property rights were measures to establish a pro-market economy in these nations.

What did the Washington Consensus actually signify?

The ten policy recommendations of the Washington Consensus were created by the British economist John-Harold Williamson.

Washington Consensus
Image by- Peterson Institute for International Economics

Well, it’s quite evident that the policy recommendations mentioned in the Washington Consensus were meant for the promotion of capitalism or the market economy in these nations which, to a great extent, followed the principles of non-market economy. As the pro-market western economies, especially the United States of America and the international monetary institutions felt that the structural reforms in these economies would only come when the economic policies of these countries would become pro-market and allow for the smooth functioning of businesses and inflow of foreign investments.

The Washington Consensus was also considered neo-liberal and a measure to promote and enhance the globalization of developing economies. Many economists also mentioned that the Washington Consensus describes the extreme capitalist belief that the markets can handle everything. 

The IMF and World Bank extensively promoted and sometimes even asserted the policies of the Washington Consensus. They asserted these policies by making them conditional for extending loans to the developing economies, this was known as stabilization and structural adjustment programs. 

Effect of the Washington Consensus on India

The balance of payment crisis
Washington Consensus
Image by- The Financial Express

Like the Latin American economies suffered high fiscal deficits, the Indian economy also faced the same crisis. India’s fiscal deficit skyrocketed from 9% of GDP in 1980-81 to 12.7% of GDP in 1990-91. The internal debt of the government also rose from 35% of GDP in 1985-86 to 53% of GDP in 1990-91. And India was already facing a high current-account deficit, importing much more than it exported. The problem of the current account deficit is still persistent in India.

The current account deficit went to extreme levels during the period caused by a massive increase in fuel prices due to the Gulf War. Rising fuel prices and an already high current account deficit drained India’s forex reserves. The conditions deteriorated to the extent that India had just enough forex reserves to afford three weeks of imports! India was close to defaulting in its debt obligations, inflation skyrocketed, investors pulled out their money, no short-term credit, and all other sorts of economic problems you can think about!

And the worst thing was, India secured an emergency loan of $2.2 billion from the IMF by pledging 67 tonnes of gold as collateral, 47 tonnes of gold to the Bank of England, and 20 tonnes of gold to the Union Bank of Switzerland for raising $600 million.

And the loans given to India by IMF, like other nations, were conditional. The IMF followed the policy of stabilization and structural adjustment programs with India. So, India, after the crisis of 1991, commenced its reform process of LPG (Liberalization, Privatization, and Globalization) under the conditions laid out by the IMF.

Washington Consensus
Image by- JournalsOfIndia

So, the assertiveness of the IMF towards these policies was quite evident. However, there’s still one question unanswered, was the Washington Consensus really effective?

Was the Washington Consensus effective?

Well, there’s a consensus that this neo-liberal set of policy reforms imposed on crisis-struck developing countries by the Washington headquartered institutions, intended for the welfare and economic development of these nations, ultimately led them to misery!

Williamson himself was quite skeptical after observing the results and mentioned it as somewhat unfortunate. Williamson defended the assertiveness of the IMF and the USA by stating that he didn’t felt that these policy prescriptions represented a set of rules that were imposed on the developing nations and also stated that it was just a list of policies he believed were widely held in Washington to be desirable in Latin America. Williamson further asserts that he never intended the terms to imply policies like capital account liberalization, monetarism, supply-side economics, or minimal state (getting the state out of welfare provisions and income redistribution).

The critics

The policies were indeed pro-market in nature and were determined to reduce and even remove state intervention in the economy, which didn’t really prove to be effective for many countries. Critics assert that the policy of fiscal discipline led to economic hardships for these nations as the governments had to cut spendings when they really needed to spend for their people and this fiscal consolidation didn’t really enhance economic growth but rather stagnated it.

Image by- Medium

The policy of privatization was considered anti-welfare, as the strategic public enterprises were also privatized, for example- the privatization of the Bolivian water industry.

The policy of the redirection of public spending was misinterpreted by these nations and the money wasn’t really redirected for the development of public schools, healthcare facilities, or infrastructure development, but was rather spent to support the market-oriented policies of the government.

Many critics also believe that the U.S. sub-prime crisis and economic recession in other developed western economies were caused by the ideas promoted by the Washington Consensus! So, after the crisis, the consensus developed that the ideas of Washington consensus were clearly ruinous. After the crisis, the consensus was in the favor of state intervention in the economy.

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