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Living in a Globalised WorldLecture 3

Washington Consensus Economics

George Irvin

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1. What is Washington Consensus?

2. Simple Theory: the Savings Balances

3. How good a record? (East Asia revisited)

4. Is there a Brussels-Frankfurt-Washington Consensus?

Outline of Session

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‘Bretton Woods’ (1944) organisations

WB funds Investment Projects & Programmes

IMF is CB ‘lender of last resort’ ‘conditional’ tranches why IMF loans needed ‘standby’ agreement and ‘letters of credit’

Regaining ‘creditworthy’ status

IMF and WB

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1. Fiscal discipline: cut Govt expenditure to balance budget; independent Central Bank controls inflation

       2. Liberalisation of prices and markets:

‘free’ capital markets make labour markets ‘more flexible’,

3. Trade liberalisation: dismantle tariffs; exchange rate liberalisation

         4. Shrink the State, mainly by privatising everything that can be

privatised; PPPs and PFIs         In summary: Fiscal austerity, Liberalisation, Privatisation,

IMF Basic Recipe

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1. Nat Y identity: Y = C + I + G + (X-M)   2. Disposition of Y identity: Y = C + Sp + T

  gives: C + Sp + T = C + I + G + (X-M); rearranging: 

3. Savings balance: (Sp – I) + (T – G) = (X – M) where:

(Sp – I) is private savings and investment; (T – G) is the Govt current surplus or deficit; (X – M) is a simplification of the CA balance

Simple Economic Logic

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Savings balance: (Sp – I) + (T – G) = (X – M)

Assume Sp = I;

then if T<G, there must be an external deficit:

Govt Deficit (-100) => Trade Deficit (-100)

(T – G) = (X – M)

Main IMF argument: Govt deficit causes trade deficit!

Key Point

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(Sp – I) + (T – G) = (X – M)

Sp: improve financial sector intermediation (end ‘McKinnon-Shaw financial repression) thus enabling Sp to rise;

G: too much G finances subsidies to ‘inefficient’ PS enterprises; these should be privatised;

i: also, reducing G takes pressure off Government financial borrowing requirement (PBR), enabling i-rts to fall and reducing ‘crowding out’ of private Investment

(X- M): end import protection, thus enabling switch of resources exports.

In some cases, devalue---although IMF tends to believe in ‘exchange rate anchor’ as a bulwark against inflation---so ‘expenditure cutting’ must be used instead.

More detailed:

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Private capital flows: (world K-markets turnover = $1.6 trillion daily!). Liberalising an LDC’s capital markets means potentially accessing a lot of investor’s money. Short-term ‘Hot money’ is the chief problem:

Spectrum of K-FlowsShort <=

============================================longMoney Mkt & Portfolio I ... DFI

 Long-term DFI: Direct Foreign Investment (typically in bricks &

mortar); can be wholly owned subsidiary, joint venture, management contract, etc.

 Short-term: called ‘hot money’: it can flow out as quickly as it flows in - Portfolio: stocks & bonds of host country; - Money market: short-term private or public paper, or simply

placing money on deposit account drawing high i-rate.. - China has exchange controls: greatly reduces volatility!

Liberalising K-Mkt

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IMF CrisesIMF-Crises: 12 crises in 10 years

Mexico (1994-95); ‘tequila crisis’Argentina(1995); ‘contagion’Thailand (1997)Indonesia (1997)S Korea (1997) Asia: induced by ‘financial mkt liberalistion’; Malaysia (1997)* * refused IMF advicePhilippines (1997)

Russia (1998) ‘bailout’: ER aid to save Chase Manhattan

Brazil (1999, 2001)Ecuador (1999) too little too lateArgentina (2001-2)

Turkey (2002)

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IMF = Reduce GrowthEast Asia:

•IMF-style policies led to falls in 1998 GDP of 14% in Indonesia, 10% in Thailand and 6% in S Korea; unemployment rose and real wages fell (-6% Korea; -7% Thailand; -38% Indonesia). •In all cases the IMF prescription was the same; higher interest rates and rigid budgetary austerity.

•Thailand had a large external deficit and Thai banks had borrowed in dollars and lent in baht; when foreign investment dried up, the baht was forced to float---but the budget deficit was not large, and demanding a budget surplus plunged the economy into recession.

•In Korea, the internal and external balances were perfectly sound; IMF forced budget-surplus induced contraction which caused serious bankruptcy

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Euro is a good thing (protects against currency shocks), but ……

Economic Architecture of EU? Central monetary authority (ECB): 2% inflation target

Fiscal policy: Stability & Growth Pact constrains state-level fiscal policy to 3% deficit and automatic stabilisers

Long term budget balance: reduces PBR to zero, thus ‘shrinking’ the State

Core Eurozone unemployment remains 9%

Key point: low growth means high unemployment, cuts in social provision

Is there a Brussels Consensus?

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Suggested References:

Stiglitz, Joseph (2002) ‘Globalisation and its discontents’ London: Penguin Books

Williamson, J. ed (1990) Latin American Adjustment: how much has happened? Washington DC: Institute for International Economics

Chang Ha-Joon (2002) ‘Kicking away the ladder: development strategy in historical perspective’ London: Anthem Books.

Fitoussi, J-P and F Saraceno (2004) ‘The Brussels-Frankfurt-Washington Consensus Old and New Tradeoffs in Economics’ Paris: (OFCE) Observatoire Français des Conjonctures Economiques N° 2004-02, February

Irvin, G (2005) ‘The Implosion of the Brussels Consensus’ Torino: ICER, May. www.icer.it

Standing, G (2004) ‘Evolution of the Washington Consensus: Economic Insecurity as Discontent’ Geneva: International Labour Office

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Debate: Resolved: ‘The IMF is a much maligned

organisation; it serves the crucial purpose of keeping the world’s governments from indulging in irresponsible spending’

The Case For The Case Against