WILLIAMSON - What Washington Means (LEER)

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What Washington Means by Policy Reform by John Williamson , Peterson Institute for International Economics

Chapter 2 from Latin American Adjustment: How Much Has Happened?Edited by John Williamson. Published April 199 .

!o"ember 2 2 Peterson Institute for International Economics

!o statement about ho# to deal #ith the debt crisis in $atin America #ould be complete #ithout acall for the debtors to fulfill their part of the proposed bar%ain by &settin% their houses in order,&&underta'in% policy reforms,& or &submittin% to stron% conditionality.& (he )uestion posed in this

paper is #hat such phrases mean, and especially #hat they are %enerally interpreted as meanin% inWashin%ton. (hus the paper aims to set out #hat #ould be re%arded in Washin%ton as constitutin% adesirable set of economic policy reforms. An important purpose in doin% this is to establish a

baseline a%ainst #hich to measure the e*tent to #hich "arious countries ha"e implemented thereforms bein% ur%ed on them.

(he paper identifies and discusses 1 policy instruments about #hose proper deploymentWashin%ton can muster a reasonable de%ree of consensus. In each case an attempt is made tosu%%est the breadth of the consensus, and in some cases I su%%est #ays in #hich I #ould #ish to seethe consensus "ie# modified. (he paper is intended to elicit comment on both the e*tent to #hichthe "ie#s identified do indeed command a consensus and on #hether they deser"e to command it. Itis hoped that the country studies to be %uided by this bac'%round paper #ill comment on the e*tentto #hich the Washin%ton consensus is shared in the country in )uestion, as #ell as on the e*tent to#hich that consensus has been implemented and the results of its implementation +ornonimplementation .

(he Washin%ton of this paper is both the political Washin%ton of Con%ress and senior members ofthe administration and the technocratic Washin%ton of the international financial institutions, theeconomic a%encies of the - %o"ernment, the /ederal 0eser"e oard, and the thin' tan's. (heInstitute for International Economics made a contribution to codifyin% and propa%atin% se"eralaspects of the Washin%ton consensus in its publication Toward Renewed Economic rowth in Latin

America + alassa et al. 19 3 . Washin%ton does not, of course, al#ays practice #hat it preaches toforei%ners.

(he 1 topics around #hich the paper is or%ani4ed deal #ith polic! instruments rather thanob5ecti"es or outcomes. (hey are economic policy instruments that I percei"e &Washin%ton& to thin'important, as #ell as on #hich some consensus e*ists. It is %enerally assumed, at least in

technocratic Washin%ton, that the standard economic ob5ecti"es of %ro#th, lo# inflation, a "iable balance of payments, and an e)uitable income distribution should determine the disposition of such policy instruments.

(here is at least some a#areness of the need to ta'e into account the impact that some of the policyinstruments in )uestion can ha"e on the e*tent of corruption. Corruption is percei"ed to be

per"asi"e in $atin America and a ma5or cause of the re%ion6s poor performance in terms of both lo#%ro#th and ine%alitarian income distribution. (hese implications #ill be mentioned belo# #herethey seem to be important.

Washin%ton certainly has a number of other concerns in its relationship #ith its $atin nei%hbors+and, for that matter, #ith other countries besides furtherin% their economic #ell7bein%. (heseinclude the promotion of democracy and human ri%hts, suppression of the dru% trade, preser"ation

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of the en"ironment, and control of population %ro#th. /or better or #orse, ho#e"er, these broaderob5ecti"es play little role in determinin% Washin%ton6s attitude to#ard the economic policies it ur%eson $atin America. $imited sums of money may be offered to countries in return for specific acts tocombat dru%s, to sa"e tropical forests, or +at least prior to the 0ea%an administration to promote

birth control, and sanctions may occasionally be imposed in support of democracy or human ri%hts, but there is little perception that the policies discussed belo# ha"e important implications for any of

those ob5ecti"es. Political Washin%ton is also, of course, concerned about the strate%ic andcommercial interests of the -nited tates, but the %eneral belief is that these are best furthered by

prosperity in the $atin countries. (he most ob"ious possible e*ception to this percei"ed harmony ofinterests concerns the - national interest in continued receipt of debt ser"ice from $atin America.

ome +but not all belie"e this consideration to ha"e been important in moti"atin% Washin%ton6ssupport for policies of austerity in $atin America durin% the 19 s.

Fiscal Deficits

Washin%ton belie"es in fiscal discipline. Con%ress enacted 8ramm70udman7 ollin%s #ith a "ie# torestorin% a balanced bud%et by 199:. Presidential candidates deplore bud%et deficits before andafter bein% elected. (he International ;onetary /und +I;/ has lon% made the restoration of fiscal

discipline a central element of the hi%h7conditionality pro%rams it ne%otiates #ith its members that#ish to borro#. Amon% ri%ht7#in% thin' tan's there may be a fe# belie"ers in 0icardiane)ui"alence


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(he e*a%%eration of bud%et deficits by inclusion of the inflationary component of interest on%o"ernment debt is not the only inade)uacy of public7sector accountin%. ;ost of the other)uestionable practices seem to in"ol"e understatement of the true deficit@

Contin%ent e*penditures, such as the %uarantees %i"en to sa"in%s and loan institutions in the-nited tates, are rarely included in reported bud%et outlays.

Interest subsidies and some other e*penditures are sometimes pro"ided by the central ban'rather than from the bud%et.

Pri"ati4ation proceeds are sometimes recorded as re"enues rather than as a means offinancin% a fiscal deficit.

(he buildup of future liabilities of the social security system is not included in bud%etoutlays.

>espite the si%nificant differences in the interpretation of fiscal discipline, I #ould maintain thatthere is "ery broad a%reement in Washin%ton that lar%e and sustained fiscal deficits are a primarysource of macroeconomic dislocation in the forms of inflation, payments deficits, and capital fli%ht.(hey result not from any rational calculation of e*pected economic benefits, but from a lac' of the

political coura%e or honesty to match public e*penditures and the resources a"ailable to financethem. -nless the e*cess is bein% used to finance producti"e infrastructure in"estment, anoperational bud%et deficit in e*cess of around 1 to 2 percent of 8!P 1 is prima facie e"idence of

policy failure. ;oreo"er, a smaller deficit, or e"en a surplus, is not necessarily e"idence of fiscaldiscipline@ its ade)uacy needs to be e*amined in the li%ht of the stren%th of demand and thea"ailability of pri"ate sa"in%s.

Public Expenditure Priorities

When a fiscal deficit needs to be cut, a choice arises as to #hether this should be accomplished byincreasin% re"enues or by reducin% e*penditures. ?ne of the le%acies of the 0ea%an administrationand its &supply7side& allies has been to create a preference in Washin%ton for reducin% e*penditures

rather than increasin% ta* re"enues, althou%h it is not clear that this preference is "ery stron% outsideof ri%ht7#in% political circles +includin% the ri%ht7#in% thin' tan's .

;uch stron%er "ie#s are held, especially in the international institutions, about the composition of public e*penditures. ;ilitary e*penditures are sometimes pri"ately deplored, but in %eneral they arere%arded as the ultimate prero%ati"e of so"erei%n %o"ernments and accordin%ly off limits tointernational technocrats. E*penditures on public administration are reco%ni4ed as necessary,althou%h sometimes they are belie"ed to be unnecessarily bloated, especially #here corruption isout of hand. ut there are three ma5or e*penditure cate%ories on #hich "ie#s are stron%ly held@subsidies, education and health, and public in"estment.

ubsidies, especially indiscriminate subsidies +includin% subsidies to co"er the losses of state

enterprises are re%arded as prime candidates for reduction or preferably elimination. E"eryone hashorror stories about countries #here subsidi4ed %asoline is cheaper than drin'in% #ater, or #heresubsidi4ed bread is so cheap that it is fed to pi%s, or #here telephone calls cost a cent or so becausesomeone for%ot +or lac'ed the coura%e to raise prices to 'eep pace #ith inflation, or #heresubsidi4ed &a%ricultural credit& is desi%ned to buy the support of po#erful lando#ners, #ho

promptly recycle the funds to buy %o"ernment paper. (he result is not 5ust a drain on the bud%et butalso much #aste and resource misallocation, #ith little reason to e*pect any offset fromsystematically fa"orable effects on income distribution, at least #here indiscriminate subsidies areconcerned.

Education and health, in contrast, are re%arded as )uintessentially proper ob5ects of %o"ernmente*penditure + alassa et al. 19 3, chapter . (hey ha"e the character of in"estment +in humancapital as #ell as consumption. ;oreo"er, they tend to help the disad"anta%ed. (his is an ob5ecti"e

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Interest Rates

(#o %eneral principles about the le"el of interest rates #ould seem to command considerablesupport in Washin%ton. ?ne is that interest rates should be mar'et7determined. (he ob5ecti"e of thisis to a"oid the resource misallocation that results from bureaucrats rationin% credit accordin% toarbitrary criteria +Pola' 19 9 . (he other principle is that real interest rates should be positi"e, so asto discoura%e capital fli%ht and, accordin% to some, increase sa"in%s. ;any, includin% myself,#ould )ualify this statement to say that interest rates should be positi"e but moderate, so as to

promote producti"e in"estment and a"oid the threat of an e*plosion in %o"ernment debt.

(he )uestion ob"iously arises as to #hether these t#o principles are mutually consistent. -ndernoncrisis conditions, I see little reason to anticipate a contradiction one e*pects mar'et7determinedinterest rates to be positi"e but moderate in real terms, althou%h hi%h international interest rates mayma'e it difficult to hold rates )uite as moderate as mi%ht be desired. -nder the sort of crisisconditions that much of $atin America has e*perienced for most of the 19 s, ho#e"er, it is all tooeasy to belie"e that mar'et7determined interest rates may be e*tremely hi%h. it is then of interest toe*amine #hether either principle has been follo#ed or #hat sort of compromise bet#een the t#omay ha"e been achie"ed. In particular, it is still of interest to e*amine #hether the credit mar'et is

se%mented and channelin% lo#7cost funds to &priority& sectors and, if so, #hat those sectors are and#hether their selection has any economic rationale. (he suspicion is that such se%mented creditmar'ets pro"ide a prime en"ironment for corruption to flourish.

The Exchange Rate

$i'e interest rates, e*chan%e rates may be determined by mar'et forces, or their appropriatenessmay be 5ud%ed on the basis of #hether their le"el seems consistent #ith macroeconomic ob5ecti"es.Althou%h there is some support in Washin%ton for re%ardin% the former principle as the moreimportant +a "ie# held in particular by those #ho deny the possibility of estimatin% e)uilibriume*chan%e rates , the dominant "ie# is that achie"in% a &competiti"e& e*chan%e rate is moreimportant than ho# the rate is determined. In particular, there is relati"ely little support for thenotion that liberali4ation of international capital flo#s is a priority ob5ecti"e for a country thatshould be a capital importer and ou%ht to be retainin% its o#n sa"in%s for domestic in"estment.

(he test of #hether an e*chan%e rate is appropriate is #hether it is consistent in the medium run#ith macroeconomic ob5ecti"es +as in my concept of the &fundamental e)uilibrium e*chan%e rate,&or /EE0 see Williamson 19 D . In the case of a de"elopin% country, the real e*chan%e rate needs to

be sufficiently competiti"e to promote a rate of e*port %ro#th that #ill allo# the economy to %ro#at the ma*imum rate permitted by its supply7side potential, #hile 'eepin% the current accountdeficit to a si4e that can be financed on a sustainable basis. (he e*chan%e rate should not be morecompetiti"e than that, because that #ould produce unnecessary inflationary pressures and also limitthe resources a"ailable for domestic in"estment, and hence curb the %ro#th of supply7side potential.

8ro#th of nontraditional e*ports is dependent not 5ust on a competiti"e e*chan%e rate at a particular point in time, but also on pri"ate7sector confidence that the rate #ill remain sufficiently competiti"ein the future to 5ustify in"estment in potential e*port industries +for recent e"idence, see Paredes19 9 . (hus, it is important to assess the stability of the real e*chan%e rate as #ell as its le"el.

A competiti"e real e*chan%e rate is the first essential element of an &out#ard7oriented& economic policy, #here the balance of payments constraint is o"ercome primarily by e*port %ro#th ratherthan by import substitution. (here is a "ery stron%ly held con"iction in Washin%ton that out#ardorientation and e*pandin% e*ports


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Trade Policy

(he second element of an out#ard7oriented economic policy is import liberali4ation. Access toimports of intermediate inputs at competiti"e prices is re%arded as important to e*port promotion,#hile a policy of protectin% domestic industries a%ainst forei%n competition is "ie#ed as creatin%costly distortions that end up penali4in% e*ports and impo"erishin% the domestic economy. (heideal is a situation in #hich the domestic resource cost of %eneratin% or sa"in% a unit of forei%ne*chan%e is e)uali4ed bet#een and amon% e*port and import7competin% industries.

(he #orst form of protection is considered to be import licensin%, #ith its massi"e potential forcreatin% opportunities for corruption. (o the e*tent that there has to be protection, let it be pro"ided

by tariffs, so that at least the public purse %ets the rents. And 'eep distortions to a minimum bylimitin% tariff dispersion and e*emptin% from tariffs imports of intermediate %oods needed to

produce e*ports.

(he free trade ideal is %enerally +althou%h perhaps not uni"ersally conceded to be sub5ect to t#o)ualifications. (he first concerns infant industries, #hich may merit substantial but strictlytemporary protection. /urthermore, a moderate %eneral tariff +in the ran%e of 1 percent to 2

percent, #ith little dispersion mi%ht be accepted as a mechanism to pro"ide a bias to#arddi"ersifyin% the industrial base #ithout threatenin% serious costs. (he second )ualification concernstimin%. A hi%hly protected economy is not e*pected to dismantle all protection o"erni%ht. ie#sdiffer, ho#e"er, on #hether import liberali4ation should proceed accordin% to a predeterminedtimetable +the World an' "ie#, embodied in many structural ad5ustment loans or #hether thespeed of liberali4ation should "ary endo%enously, dependin% on ho# much the state of the balanceof payments can tolerate +my o#n "ie#, based on recollection of ho# Europe liberali4edsuccessfully in the 19D s .

Foreign Direct Investment

As noted abo"e, liberali4ation of forei%n financial flo#s is not re%arded as a hi%h priority. Incontrast, a restricti"e attitude limitin% the entry of forei%n direct in"estment +/>I is re%arded asfoolish. uch in"estment can brin% needed capital, s'ills, and 'no#7ho#, either producin% %oodsneeded for the domestic mar'et : or contributin% ne# e*ports. (he main moti"ation for restrictin%/>I is economic nationalism, #hich Washin%ton disappro"es of, at least #hen practiced bycountries other than the -nited tates.

/>I can be promoted by debt7e)uity s#aps. Parts of Washin%ton, perhaps most notably the -(reasury, the Institute of International /inance, and the International /inance Corporation, arestron%ly in fa"or of debtor countries facilitatin% debt7e)uity s#aps, on the ar%ument that this cansimultaneously further the t#in ob5ecti"es of promotin% />I and reducin% debt. ?ther parts ofWashin%ton, notably the I;/, are much more s'eptical. (hey )uestion #hether />I should besubsidi4ed they as' #hether the subsidi4ed in"estment #ill be additional they ar%ue that, if it isnot, the debtor loses by ha"in% its forei%n debt reduced rather than %ainin% free forei%n e*chan%eand abo"e all they #orry about the inflationary implications of addin% to domestic monetarye*pansion.

Privati ation

>ebt7e)uity s#aps in"ol"e no monetary pressure #hen the e)uity purchased by the forei%n in"estoris bou%ht from the %o"ernment, in the course of an enterprise bein% pri"ati4ed. (his is one attractionseen in pri"ati4ation. ;ore %enerally, pri"ati4ation may help relie"e the pressure on the %o"ernment

bud%et, both in the short run by the re"enue produced by the sale of the enterprise and in the lon%errun inasmuch as in"estment need no lon%er be financed by the %o"ernment.

o#e"er, the main rationale for pri"ati4ation is the belief that pri"ate industry is mana%ed more

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efficiently than state enterprises, because of the more direct incenti"es faced by a mana%er #hoeither has a direct personal sta'e in the profits of an enterprise or else is accountable to those #hodo. At the "ery least, the threat of ban'ruptcy places a floor under the inefficiency of pri"ateenterprises, #hereas many state enterprises seem to ha"e unlimited access to subsidies. (his beliefin the superior efficiency of the pri"ate sector has lon% been an article of faith in Washin%ton+thou%h perhaps not held )uite as fer"ently as in the rest of the -nited tates , but it #as only #ith

the enunciation of the a'er Plan in 19 D that it became official - policy to promote forei%n pri"ati4ation. (he I;/ and the World an' ha"e duly encoura%ed pri"ati4ation in $atin Americaand else#here since.

(he lac' of a stron% indi%enous pri"ate sector is one reason that has moti"ated some countries to promote state enterprises. (his is a%ain a nationalistic moti"ation and hence commands little respectin Washin%ton.

;y o#n "ie# is that pri"ati4ation can be "ery constructi"e #here it results in increasedcompetition, and useful #here it eases fiscal pressures, but I am not persuaded that public ser"ice isal#ays inferior to pri"ate ac)uisiti"eness as a moti"atin% force. -nder certain circumstances, suchas #here mar%inal costs are less than a"era%e costs +for e*ample, in public transport or in the

presence of en"ironmental spillo"ers too comple* to be easily compensated by re%ulation +fore*ample, in the case of #ater supply , I continue to belie"e public o#nership to be preferable to

pri"ate enterprise. ut this "ie# is not typical of Washin%ton.

Deregulation

Another #ay of promotin% competition is by dere%ulation. (his #as initiated #ithin the -nitedtates by the Carter administration and carried for#ard by the 0ea%an administration. It is %enerally

5ud%ed to ha"e been successful #ithin the -nited tates, and it is %enerally assumed that it could brin% similar benefits to other countries.

(he potential payoff from dere%ulation #ould seem to be much %reater in $atin America, to 5ud%efrom the assessment in alassa et al. +19 3, 1: @

;ost of the lar%er $atin American countries are amon% the #orld6s most re%ulatedmar'et economies, at least on paper. Amon% the most important economic re%ulatorymechanisms are controls on the establishment of firms and on ne# in"estments,restrictions on inflo#s of forei%n in"estment and outflo#s of profit remittance, pricecontrols, import barriers, discriminatory credit allocation, hi%h corporate income ta*rates combined #ith discretionary ta*7reduction mechanisms, as #ell as limits on firin%of employees.... In a number of $atin American countries, the #eb of re%ulation isadministered by underpaid administrators. (he potential for corruption is therefore%reat.

Producti"e acti"ity may be re%ulated by le%islation, by %o"ernment decrees, and case7 by7case decision ma'in%. (his latter practice is #idespread and pernicious in $atinAmerica as it creates considerable uncertainty and pro"ides opportunities for corruption.It also discriminates a%ainst small and medium7si4ed businesses #hich, althou%himportant creators of employment, seldom ha"e access to the hi%her reaches of the

bureaucracy.

Property Rights

In the -nited tates property ri%hts are so #ell entrenched that their fundamental importance for thesatisfactory operation of the capitalist system is easily o"erloo'ed. I suspect, ho#e"er, that #hen

Washin%ton brin%s itself to thin' about the sub5ect, there is %eneral acceptance that property ri%hts

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do indeed matter. (here is also a %eneral perception that property ri%hts are hi%hly insecure in $atinAmerica +see, for e*ample, alassa et al. 19 3, chapter .

Washington!s Practice

Washin%ton does not al#ays practice #hat it preaches, as a moment6s reflection on the mostembarrassin% sub5ect mentioned abo"eepartment of ousin% and -rban>e"elopment came to li%ht


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Washin%ton a%enda described abo"e can be relied on to restore %ro#th once stabili4ation has beenachie"ed. e points to the disappointin% e*periences of oli"ia and ;e*ico, #here determined andeffecti"e stabili4ation has not yet resulted in a resumption of %ro#th. If he is ri%ht in his contentionthat entrepreneurs may adopt a #ait7and7see policy after stabili4ation rather than promptlycommittin% themsel"es to the ris's in"ol"ed in ne# in"estment, the important )uestion arises as to#hat must be added to Washin%ton6s policy ad"ice in order to restore %ro#th.

A third important issue concerns capital fli%ht. /iscal discipline, positi"e real interest rates, acompetiti"e e*chan%e rate, and more secure property ri%hts are all important for re"ersin% capitalfli%ht. ut it is doubtful #hether all those reforms to%ether #ould lead to a prompt return of fli%htcapital. Elimination of the current ta* incenti"e to 'eep money abroad #ould surely help too+$essard and Williamson 19 B , but this is certainly not a policy on #hich Washin%ton has yetreached a consensus, nor is it clear that addin% it #ould be enou%h to do the tric'.

E"en thou%h the Washin%ton consensus may not be sufficient to resol"e all the ma5or $atin problems, it is surely of interest to as'@

Is the consensus shared in $atin AmericaF

a"e the recommended policies been implemented in $atin AmericaF What results ha"e been achie"ed #here the recommended policies ha"e been implementedF

(hose are the )uestions that the country studies are bein% as'ed to address. Ans#erin% them #ill atleast help to clear the %round for e*aminin% #hat additional policies may be needed to limit thetransitional costs of inflation stabili4ation, to restore %ro#th, and to re"erse capital fli%ht.

?ne final reflection@ A stri'in% fact about the list of policies on #hich Washin%ton does ha"e acollecti"e "ie# is that they all stem from classical mainstream economic theory, at least if one isallo#ed to count =eynes as a classic by no#. !one of the ideas spa#ned by the de"elopmentliteratureonard 0., and John Williamson, eds. 19 B. .apital $li)ht and Third 'orld /e0t .Washin%ton@ Institute for International Economics.

Paredes, Carlos. 19 9. & E*chan%e 0ate 0e%imes, the 0eal E*chan%e 0ate, and E*port Performance

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in $atin America.& Washin%ton@ roo'in%s Institution.

Pola', Jac)ues J. 19 9. /inancial Policies and >e"elopment. Paris@ ?r%ani4ation for EconomicCooperation and >e"elopment.

hleifer, Andrei. 19 9. &Preconditions !ecessary for the 0eco"er of $atin America6s 8ro#th.&Presented at a conference on (he Economic 0econstruction of $atin America at the /undaH o

8et lio ar%as, 0io de Janeiro +B7 Au%ust .(an4i, ito. 19 9. &/iscal Policy and Economic 0estructurin% in $atin America.& Presented at aconference on (he Economic 0econstruction of $atin America at the /undaH o 8et lio ar%as, 0iode Janeiro +B7 Au%ust .

Williamson, John. 19 D. The E"chan)e Rate 1!stem . Policy Analyses in International Economics D.Washin%ton@ Institute for International Economics.

$otes

1. (his fi%ure assumes a desire to stabili4e the debt78!P ratio, /23 , at no more than . . Assume areal %ro#th rate, ?323 , of . . (hen ?/2/ L ?323 M implies ?/23 M323 * /23 N . * . N

. 13.

2. ee, for e*ample, Camdessus6 address to the -nited !ations Economic and ocial Council in8ene"a on 23 June 19 B + IM$ 1ur4e! , 29 June 19 B and the inter"ie# #ith Conable in Istanbul on19 ;ay 19 9.

:. An e*ception to the case for #elcomin% />I can arise if the domestic mar'et in )uestion ishea"ily protected, #hen the %ro#th produced by forei%n in"estment can be immiseri4in%@ see

recher and >Ka4 Ale5andro +19BB .

. ome mi%ht #ant to add the debt issue as a fourth topic on #hich it is not clear that the

Washin%ton a%enda suffices to resol"e the current problem, but this seems to me unfair. (he radyPlan is based on the premise that official help in achie"in% debt reduction should be %i"en to thosecountries that ha"e &put their houses in order,& #hich implies that the latter alone is not e*pected toachie"e a resolution of the debt problem.

D. Ironically, Washin%ton seems to ha"e reached this position 5ust as Chica%o theorists ha"eredisco"ered the old ideas of e*ternalities that underlay the de"elopment literature@ see hleifer+19 9 for a sur"ey of the ne# literature on the theory of de"elopment.

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WILLIAMSON - What Washington Means (LEER)