Neoliberal economic system
Chapter 2 - Society
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Welcome to the Neoliberal economic system page
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The industrial revolution and capitalism grew together from the possibility of exploiting raw materials and energy sources, especially coal in the UK. This was the basis for setting in motion a second movement: efficiency gains. Energy ensured that tools were developed that could exploit raw materials better and faster. The money earned from this could be used to develop efficiency-enhancing developments.
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Core ideas
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The assumptions of the standard (neoliberal) economic model
Macro-economics
- Firms get utility from making profits while minimising risk
- Persons and households get utility from consumption
- Each agent (person, household, firm, ...) makes decisions that make their utility as large as possible
Meso-economics
- By the law of supply and demand, quantity and prices will level on an equilibrium
- Prices will level on the lowes equilibrium because producs are offered on different markets
Micro-economics
- Agents (home economicus) are intelligent enough to reason their way through any problem
- They use all available information to make the best possible decision (the one with the highest utility)
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Neo-classical definition of economics
Economics is generally defined as the study of allocating scarce resources to maximise welfare. In conventional economics, the key resources, or inputs, are labour and capital.
The economy is generally understood as a system with a circular exchange flow between households and businesses. Households provide firms not just with labour but also land, natural resources, and financial capital, which they collectively own. In return, they receive payments in the form of wages, interest, dividends, rents, and profits. Firms combine these 'factors of production' to produce goods and services that are consumed by households.
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Neo-classical definition of price
Markets value and assign costs (or prices) only to those things which can be exchanged. To be traded on a market, something must be subject to exclusive ownership and control and the ability to transfer that exclusivity. This implies it must be quantifiable in some way. Yet many things that constitute natural resources – the sun, the air, the sea, wild birds or biodiversity – cannot be quantified, exclusively owned and hence cannot be exchanged on markets.
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Neo-classical definition of capital
All the inputs to production apart from labour are grouped together under the term 'capital'. This has the necessary consequence of implying that one can be substituted for the other. In other words, depleting nature's resources does not matter as long as the stock of man-made capital increases.
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Neo-classical definition of growth
Growth is explained mainly through increases in the quantity of labour and capital. The 'residual' economic growth, which is not explained by these two factors, is generally explained away as a result of technological advances or a 'technology multiplier'.
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Deep dive
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Neo-classical steering of the economy
Neo-classical use of GDP
Gross domestic product (or GDP) is a calculated statistic. It measures the total market value of all final goods and services produced in an economy in a year. Simply put, GDP measures the size of the economy. Economists measure economic growth by comparing GDP over time. Economic growth is usually presented as a percentage increase or decrease from an earlier period. A growing economy produces more goods and services for its population, including health care and education. And, generally speaking, more is better.
So, GDP measures production levels over a period of time, which can be adjusted for inflation and compared with earlier periods as an indication of economic growth. In general, growth is good.
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Neo-classical use of inflation
Mainstream macroeconomics offers policymakers two contending growth and stabilization strategies:
- investment-driven is more compatible with the economic policy of right-wing governments
- Increasing real interest rates will induce higher future investment rates by steering income away from consumption towards saving and reducing inflationary expectations. The behaviour of savers impacts the borrowing and lending process of banks. That is, banks borrow more savings in the short run, giving more credit to economic agents in the long run.
- whereas consumer-driven models is for the left-wing
- According to the consumer-driven model, aggregate demand growth is the key determinant of investment and economic growth. A decrease in real interest rates will increase consumer demand and sales as the cost of credit is reduced. This process leads to upturns in employment and investment, all of which will accelerate economic growth in the short run.
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Neo-classical use of depth
Credit and other payment deferrals create opportunities by bringing the future into the present. This creative power makes some forms of credit (and therefore debt) a condition for social and economic participation. For example, for those who want to buy a home, mortgage credit is an almost self-evident form of debt, even if it is not always experienced as debt by borrowers.
Debt in the financial sense is a matter of 'debtors-creditors': one person's credit is another person's debit, and someone in debt opposes someone with a claim.
Debts are the lifeblood and lubricant of the economy because they put money into circulation. Lending means using capital for investment.
Debts embody optimism, confidence in the future, and the willingness to invest and take risks. This optimism works as long as there is confidence that future earning capacity is large enough to cover the debt's interest and repayments. If it is clear that future economic growth will not be sufficient to cover the debt burden, then things get complicated. In a so-called balance sheet recession, the values of debts and assets must be returned to balance. This is accompanied by economic decline, avoiding risks, cutting back on credit, writing off outstanding debts, pessimism about the future, waiting to invest and reduced consumption.
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Recent Neoliberal history
Bretton Woods
The Bretton Woods System is a set of unified rules and policies that provided the framework necessary to create fixed international currency exchange rates. Essentially, the agreement called for the newly created IMF to determine the fixed rate of exchange for currencies around the world. Backing currency by the gold standard started to become a serious problem throughout the late 1960s. By 1971, the issue was so bad that US President Richard Nixon gave notification that the ability to convert the dollar to gold was being suspended “temporarily.” The move was inevitably the final straw for the system and the agreement that outlined it. Despite falling apart, the Bretton Woods summit and agreement are responsible for several notably essential aspects of the financial world. First and foremost is the creation of the IMF and the World Bank. Both institutions remain vital to the global economy to this day.
| Bretton Woods system |
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| The Bretton Woods system of monetary management established the rules for commercial relations among the United States, Canada, Western European countries, and Australia and other countries, a total of 44 countries after the 1944 Bretton Woods Agreement. The Bretton Woods system was the first example of a fully negotiated monetary order intended to govern monetary relations among independent states. The Bretton Woods system required countries to guarantee convertibility of their currencies into U.S. dollars to within 1% of fixed parity rates, with the dollar convertible to gold bullion for foreign governments and central banks at US$35 per troy ounce of fine gold (or 0.88867 gram fine gold per dollar). It also envisioned greater cooperation among countries in order to prevent future competitive devaluations, and thus established the International Monetary Fund (IMF) to monitor exchange rates and lend reserve currencies to nations with balance of payments deficits. |
| https://en.wikipedia.org/wiki/Bretton_Woods_system |
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The Washington Consensus
The Washington Consensus is a set of ten economic policy prescriptions considered in the 1980s and 1990s to constitute the "standard" reform package promoted for crisis-wracked developing countries by the Washington, D.C.-based institutions the International Monetary Fund (IMF), World Bank and United States Department of the Treasury. The term was first used in 1989 by English economist John Williamson. The prescriptions encompassed free-market promoting policies such as trade liberalization, privatization and finance liberalization. They also entailed fiscal and monetary policies intended to minimize fiscal deficits and minimize inflation.
The concept and name of the Washington Consensus were first presented in 1989 by John Williamson, an economist from the Institute for International Economics, an international economic think tank based in Washington, D.C.
The consensus as originally stated by Williamson included ten broad sets of relatively specific policy recommendations:
- Fiscal policy discipline, with avoidance of large fiscal deficits relative to GDP;
- Redirection of public spending from subsidies ("especially indiscriminate subsidies") toward broad-based provision of key pro-growth, pro-poor services like primary education, primary health care and infrastructure investment;
- Tax reform, broadening the tax base and adopting moderate marginal tax rates;
- Interest rates that are market determined and positive (but moderate) in real terms;
- Competitive exchange rates;
- Trade liberalization: liberalization of imports, with particular emphasis on elimination of quantitative restrictions (licensing, etc.); any trade protection to be provided by low and relatively uniform tariffs;
- Liberalization of inward foreign direct investment;
- Privatization of state enterprises;
- Deregulation: abolition of regulations that impede market entry or restrict competition, except for those justified on safety, environmental and consumer protection grounds, and prudential oversight of financial institutions;
- Legal security for property rights.
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John Williamson
As often happens, the interpretation and elaboration differ from the author's intention. .
| John Williamson |
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| The Washington Consensus is not interchangeable with the term "neoliberalism." Williamson recognizes that the term has commonly been used with a different meaning from his original prescription; he opposes the alternative use of the term, which became common after his initial formulation, to cover a broader market fundamentalism or "neoliberal" agenda.
More specifically, Williamson argues that the first three of his ten prescriptions are uncontroversial in the economic community, while recognizing that the others have evoked some controversy. He argues that one of the least controversial prescriptions, the redirection of spending to infrastructure, health care, and education, has often been neglected. He also argues that, while the prescriptions were focused on reducing certain functions of government (e.g., as an owner of productive enterprises), they would also strengthen government's ability to undertake other actions such as supporting education and health. Williamson says that he does not endorse market fundamentalism, and believes that the Consensus prescriptions, if implemented correctly, would benefit the poor. In a book edited with Pedro-Pablo Kuczynski in 2003, Williamson laid out an expanded reform agenda, emphasizing crisis-proofing of economies, "second-generation" reforms, and policies addressing inequality and social issues. |
| https://en.wikipedia.org/wiki/Washington_Consensus |
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| John Williamson |
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| Speeches, Testimony, Papers
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 1990. November 2002 © Peterson Institute for International Economics
No statement about how to deal with the debt crisis in Latin America would be complete without a call for the debtors to fulfill their part of the proposed bargain by "setting their houses in order," "undertaking policy reforms," or "submitting to strong conditionality." The question posed in this paper is what such phrases mean, and especially what they are generally interpreted as meaning in Washington. Thus the paper aims to set out what would be regarded in Washington as constituting a desirable set of economic policy reforms. An important purpose in doing this is to establish a baseline against which to measure the extent to which various countries have implemented the reforms being urged on them. The paper identifies and discusses 10 policy instruments about whose proper deployment Washington can muster a reasonable degree of consensus. In each case an attempt is made to suggest the breadth of the consensus, and in some cases I suggest ways in which I would wish to see the consensus view modified. The paper is intended to elicit comment on both the extent to which the views identified do indeed command a consensus and on whether they deserve to command it. It is hoped that the country studies to be guided by this background paper will comment on the extent to which the Washington consensus is shared in the country in question, as well as on the extent to which that consensus has been implemented and the results of its implementation (or nonimplementation). The Washington of this paper is both the political Washington of Congress and senior members of the administration and the technocratic Washington of the international financial institutions, the economic agencies of the US government, the Federal Reserve Board, and the think tanks. The Institute for International Economics made a contribution to codifying and propagating several aspects of the Washington consensus in its publication Toward Renewed Economic Growth in Latin America (Balassa et al. 1986). Washington does not, of course, always practice what it preaches to foreigners. The 10 topics around which the paper is organized deal with policy instruments rather than objectives or outcomes. They are economic policy instruments that I perceive "Washington" to think important, as well as on which some consensus exists. It is generally assumed, at least in technocratic Washington, that the standard economic objectives of growth, low inflation, a viable balance of payments, and an equitable income distribution should determine the disposition of such policy instruments. There is at least some awareness of the need to take into account the impact that some of the policy instruments in question can have on the extent of corruption. Corruption is perceived to be pervasive in Latin America and a major cause of the region's poor performance in terms of both low growth and inegalitarian income distribution. These implications will be mentioned below where they seem to be important. Washington certainly has a number of other concerns in its relationship with its Latin neighbors (and, for that matter, with other countries) besides furthering their economic well-being. These include the promotion of democracy and human rights, suppression of the drug trade, preservation of the environment, and control of population growth. For better or worse, however, these broader objectives play little role in determining Washington's attitude toward the economic policies it urges on Latin America. Limited sums of money may be offered to countries in return for specific acts to combat drugs, to save tropical forests, or (at least prior to the Reagan administration) to promote birth control, and sanctions may occasionally be imposed in support of democracy or human rights, but there is little perception that the policies discussed below have important implications for any of those objectives. Political Washington is also, of course, concerned about the strategic and commercial interests of the United States, but the general belief is that these are best furthered by prosperity in the Latin countries. The most obvious possible exception to this perceived harmony of interests concerns the US national interest in continued receipt of debt service from Latin America. Some (but not all) believe this consideration to have been important in motivating Washington's support for policies of austerity in Latin America during the 1980s. Fiscal Deficits Washington believes in fiscal discipline. Congress enacted Gramm-Rudman-Hollings with a view to restoring a balanced budget by 1993. Presidential candidates deplore budget deficits before and after being elected. The International Monetary Fund (IMF) has long made the restoration of fiscal discipline a central element of the high-conditionality programs it negotiates with its members that wish to borrow. Among right-wing think tanks there may be a few believers in Ricardian equivalence—the notion that individuals adjust their saving behavior to anticipate future taxation, so that whether public expenditure is financed by taxation or bonds has no impact on aggregate demand—who are prepared to deny the danger of large fiscal deficits, but they clearly stand outside the Washington consensus. Left-wing believers in "Keynesian" stimulation via large budget deficits are almost an extinct species. Differences of view exist, however, as to whether fiscal discipline need necessarily imply a balanced budget. One view is that a deficit is acceptable as long as it does not result in the debt-GNP ratio rising. An even more relaxed criterion would net off that part of the increased debt that has a counterpart in productive public capital formation and simply seek to prevent an increase in the net liabilities of the public sector relative to GNP. Another modification, which I find persuasive although much of Washington regards it as too "Keynesian" to endorse explicitly, argues that a balanced budget (or at least a nonincreasing debt-GNP ratio) should be a minimal medium-run norm, but that short-run deficits and surpluses around that norm should be welcomed insofar as they contribute to macroeconomic stabilization. (Note that Gramm-Rudman-Hollings is automatically suspended if the US economy goes into recession.) A variant of that view, held in some quarters where "Keynesian" is regarded as a term of abuse, is that progress toward the medium-term goal of a balanced budget should be sufficiently cautious to avoid the risk of precipitating a recession. The budget deficit has traditionally been measured in nominal terms, as the excess of government expenditures over receipts. In 1982 Brazil argued with the IMF that this way of measuring the deficit is seriously misleading in a high-inflation country, where most of the nominal interest payments on government debt are really accelerated amortization of principal. The IMF has accepted this argument (Tanzi 1989), if initially with some reluctance, and hence it sometimes now pays attention to the "operational deficit," which includes in expenditure only the real component of interest paid on government debt. (Political Washington has not yet discovered this sensible innovation, which thus remains to be exploited as a means of relaxing the Gramm-Rudman-Hollings constraints when these threaten to bite.) Indeed, Tanzi (1989) also indicates that in formulating programs the Fund has increasingly been using the "primary deficit," which excludes all interest payments from the deficit, on the ground that this includes only items that are in principle directly controllable by the authorities. (That goes too far for my taste, since real interest payments certainly have implications for aggregate demand and the evolution of the real debt of the public sector.) The exaggeration of budget deficits by inclusion of the inflationary component of interest on government debt is not the only inadequacy of public-sector accounting. Most of the other questionable practices seem to involve understatement of the true deficit:
Despite the significant differences in the interpretation of fiscal discipline, I would maintain that there is very broad agreement in Washington that large and sustained fiscal deficits are a primary source of macroeconomic dislocation in the forms of inflation, payments deficits, and capital flight. They result not from any rational calculation of expected economic benefits, but from a lack of the political courage or honesty to match public expenditures and the resources available to finance them. Unless the excess is being used to finance productive infrastructure investment, an operational budget deficit in excess of around 1 to 2 percent of GNP1 is prima facie evidence of policy failure. Moreover, a smaller deficit, or even a surplus, is not necessarily evidence of fiscal discipline: its adequacy needs to be examined in the light of the strength of demand and the availability of private savings. Public Expenditure Priorities When a fiscal deficit needs to be cut, a choice arises as to whether this should be accomplished by increasing revenues or by reducing expenditures. One of the legacies of the Reagan administration and its "supply-side" allies has been to create a preference in Washington for reducing expenditures rather than increasing tax revenues, although it is not clear that this preference is very strong outside of right-wing political circles (including the right-wing think tanks). Much stronger views are held, especially in the international institutions, about the composition of public expenditures. Military expenditures are sometimes privately deplored, but in general they are regarded as the ultimate prerogative of sovereign governments and accordingly off limits to international technocrats. Expenditures on public administration are recognized as necessary, although sometimes they are believed to be unnecessarily bloated, especially where corruption is out of hand. But there are three major expenditure categories on which views are strongly held: subsidies, education and health, and public investment. Subsidies, especially indiscriminate subsidies (including subsidies to cover the losses of state enterprises) are regarded as prime candidates for reduction or preferably elimination. Everyone has horror stories about countries where subsidized gasoline is cheaper than drinking water, or where subsidized bread is so cheap that it is fed to pigs, or where telephone calls cost a cent or so because someone forgot (or lacked the courage) to raise prices to keep pace with inflation, or where subsidized "agricultural credit" is designed to buy the support of powerful landowners, who promptly recycle the funds to buy government paper. The result is not just a drain on the budget but also much waste and resource misallocation, with little reason to expect any offset from systematically favorable effects on income distribution, at least where indiscriminate subsidies are concerned. Education and health, in contrast, are regarded as quintessentially proper objects of government expenditure (Balassa et al. 1986, chapter 4). They have the character of investment (in human capital) as well as consumption. Moreover, they tend to help the disadvantaged. This is an objective that fell under a cloud in the early years of the Reagan administration, but that has recovered its standing of the 1970s ("basic needs") in the late 1980s, aided by the prodding of UNICEF (Cornia, Jolly, and Stewart 1987). Thus, the Managing Director of the IMF, Michel Camdessus, has declared the Fund to have a concern about the impact of its programs on the poor, and more recently Barber Conable, President of the World Bank, has reasserted the Bank's commitment to seeking to end poverty.2 Just how much help expenditures on education and health in fact provide to the disadvantaged depends on their composition as well as their level. Primary education is vastly more relevant than university education, and primary health care (especially preventive treatment) more beneficial to the poor than hospitals in the capital city stuffed with all the latest high-tech medical gadgets. This is not to say that there is no need for universities or state-of-the-art hospitals: developing countries need to train and retain an educated elite as well as to raise the standards of the masses and the poorest. But it is to assert that many in Washington believe that expenditures need to be redirected toward education and health in general, and most especially in a way that will benefit the disadvantaged. The other area of public expenditure that Washington regards as productive is public infrastructure investment. There is of course a view that the public sector tends to be too large (see the section on privatization below). However, that view coexists with the view that spending on infrastructure that is properly within the public sector needs to be large (and also that an industry should not be starved of investment just because it is, however inadvisedly, within the public sector). Policy reform with regard to public expenditure is thus perceived to consist of switching expenditure from subsidies toward education and health (especially to benefit the disadvantaged) and infrastructure investment. I would add that, for my taste, the hostility toward subsidies tends to be too general. I fully sympathize with the hostility toward indiscriminate subsidies, but I also believe that there are circumstances in which carefully targeted subsidies can be a useful instrument. Thus, my own test of a country's policies would not be whether it had abolished all subsidies, but whether it could provide a convincing explicit justification for those that remain in terms of improving either resource allocation or income distribution. Tax Reform Increased tax revenues are the alternative to decreased public expenditures as a remedy for a fiscal deficit. Most of political Washington regards them as an inferior alternative. Much of technocratic Washington (with the exception of the right-wing think tanks) finds political Washington's aversion to tax increases irresponsible and incomprehensible. Despite this contrast in attitudes toward the merits of increasing tax revenue, there is a very wide consensus about the most desirable method of raising whatever level of tax revenue is judged to be needed. The principle is that the tax base should be broad and marginal tax rates should be moderate. This principle, the basis of the 1986 reform of the US income tax, was promoted with equal enthusiasm by the late Joseph A. Pechman of the Brookings Institution and Senator Bill Bradley (D-NJ) and by the "supply-siders" in Congress and the right-wing think tanks. A particular issue that arises in the Latin American context is whether an attempt should be made to include within the tax base interest income on assets held abroad ("flight capital"). By itself a single country's law subjecting such income to taxation may not have much impact because of the problem of enforcement, but a country is not even in a position to start discussions on enforcement with haven countries until it has legislated to impose taxes on the interest from flight capital (Lessard and Williamson 1987). Achieving effective taxation of the income from flight capital is bound to take a long time, but it would be interesting to know whether any countries have embarked on the effort. Interest Rates Two general principles about the level of interest rates would seem to command considerable support in Washington. One is that interest rates should be market-determined. The objective of this is to avoid the resource misallocation that results from bureaucrats rationing credit according to arbitrary criteria (Polak 1989). The other principle is that real interest rates should be positive, so as to discourage capital flight and, according to some, increase savings. Many, including myself, would qualify this statement to say that interest rates should be positive but moderate, so as to promote productive investment and avoid the threat of an explosion in government debt. The question obviously arises as to whether these two principles are mutually consistent. Under noncrisis conditions, I see little reason to anticipate a contradiction; one expects market-determined interest rates to be positive but moderate in real terms, although high international interest rates may make it difficult to hold rates quite as moderate as might be desired. Under the sort of crisis conditions that much of Latin America has experienced for most of the 1980s, however, it is all too easy to believe that market-determined interest rates may be extremely high. it is then of interest to examine whether either principle has been followed or what sort of compromise between the two may have been achieved. In particular, it is still of interest to examine whether the credit market is segmented and channeling low-cost funds to "priority" sectors and, if so, what those sectors are and whether their selection has any economic rationale. The suspicion is that such segmented credit markets provide a prime environment for corruption to flourish. The Exchange Rate Like interest rates, exchange rates may be determined by market forces, or their appropriateness may be judged on the basis of whether their level seems consistent with macroeconomic objectives. Although there is some support in Washington for regarding the former principle as the more important (a view held in particular by those who deny the possibility of estimating equilibrium exchange rates), the dominant view is that achieving a "competitive" exchange rate is more important than how the rate is determined. In particular, there is relatively little support for the notion that liberalization of international capital flows is a priority objective for a country that should be a capital importer and ought to be retaining its own savings for domestic investment. The test of whether an exchange rate is appropriate is whether it is consistent in the medium run with macroeconomic objectives (as in my concept of the "fundamental equilibrium exchange rate," or FEER; see Williamson 1985). In the case of a developing country, the real exchange rate needs to be sufficiently competitive to promote a rate of export growth that will allow the economy to grow at the maximum rate permitted by its supply-side potential, while keeping the current account deficit to a size that can be financed on a sustainable basis. The exchange rate should not be more competitive than that, because that would produce unnecessary inflationary pressures and also limit the resources available for domestic investment, and hence curb the growth of supply-side potential. Growth of nontraditional exports is dependent not just on a competitive exchange rate at a particular point in time, but also on private-sector confidence that the rate will remain sufficiently competitive in the future to justify investment in potential export industries (for recent evidence, see Paredes 1989). Thus, it is important to assess the stability of the real exchange rate as well as its level. A competitive real exchange rate is the first essential element of an "outward-oriented" economic policy, where the balance of payments constraint is overcome primarily by export growth rather than by import substitution. There is a very strongly held conviction in Washington that outward orientation and expanding exports—essentially growth in nontraditional exports—-are necessary for Latin American recovery (see, for example, Balassa et al. 1986). Trade Policy The second element of an outward-oriented economic policy is import liberalization. Access to imports of intermediate inputs at competitive prices is regarded as important to export promotion, while a policy of protecting domestic industries against foreign competition is viewed as creating costly distortions that end up penalizing exports and impoverishing the domestic economy. The ideal is a situation in which the domestic resource cost of generating or saving a unit of foreign exchange is equalized between and among export and import-competing industries. The worst form of protection is considered to be import licensing, with its massive potential for creating opportunities for corruption. To the extent that there has to be protection, let it be provided by tariffs, so that at least the public purse gets the rents. And keep distortions to a minimum by limiting tariff dispersion and exempting from tariffs imports of intermediate goods needed to produce exports. The free trade ideal is generally (although perhaps not universally) conceded to be subject to two qualifications. The first concerns infant industries, which may merit substantial but strictly temporary protection. Furthermore, a moderate general tariff (in the range of 10 percent to 20 percent, with little dispersion) might be accepted as a mechanism to provide a bias toward diversifying the industrial base without threatening serious costs. The second qualification concerns timing. A highly protected economy is not expected to dismantle all protection overnight. Views differ, however, on whether import liberalization should proceed according to a predetermined timetable (the World Bank view, embodied in many structural adjustment loans) or whether the speed of liberalization should vary endogenously, depending on how much the state of the balance of payments can tolerate (my own view, based on recollection of how Europe liberalized successfully in the 1950s). Foreign Direct Investment As noted above, liberalization of foreign financial flows is not regarded as a high priority. In contrast, a restrictive attitude limiting the entry of foreign direct investment (FDI) is regarded as foolish. Such investment can bring needed capital, skills, and know-how, either producing goods needed for the domestic market3 or contributing new exports. The main motivation for restricting FDI is economic nationalism, which Washington disapproves of, at least when practiced by countries other than the United States. FDI can be promoted by debt-equity swaps. Parts of Washington, perhaps most notably the US Treasury, the Institute of International Finance, and the International Finance Corporation, are strongly in favor of debtor countries facilitating debt-equity swaps, on the argument that this can simultaneously further the twin objectives of promoting FDI and reducing debt. Other parts of Washington, notably the IMF, are much more skeptical. They question whether FDI should be subsidized; they ask whether the subsidized investment will be additional; they argue that, if it is not, the debtor loses by having its foreign debt reduced rather than gaining free foreign exchange; and above all they worry about the inflationary implications of adding to domestic monetary expansion. Privatization Debt-equity swaps involve no monetary pressure when the equity purchased by the foreign investor is bought from the government, in the course of an enterprise being privatized. This is one attraction seen in privatization. More generally, privatization may help relieve the pressure on the government budget, both in the short run by the revenue produced by the sale of the enterprise and in the longer run inasmuch as investment need no longer be financed by the government. However, the main rationale for privatization is the belief that private industry is managed more efficiently than state enterprises, because of the more direct incentives faced by a manager who either has a direct personal stake in the profits of an enterprise or else is accountable to those who do. At the very least, the threat of bankruptcy places a floor under the inefficiency of private enterprises, whereas many state enterprises seem to have unlimited access to subsidies. This belief in the superior efficiency of the private sector has long been an article of faith in Washington (though perhaps not held quite as fervently as in the rest of the United States), but it was only with the enunciation of the Baker Plan in 1985 that it became official US policy to promote foreign privatization. The IMF and the World Bank have duly encouraged privatization in Latin America and elsewhere since. The lack of a strong indigenous private sector is one reason that has motivated some countries to promote state enterprises. This is again a nationalistic motivation and hence commands little respect in Washington. My own view is that privatization can be very constructive where it results in increased competition, and useful where it eases fiscal pressures, but I am not persuaded that public service is always inferior to private acquisitiveness as a motivating force. Under certain circumstances, such as where marginal costs are less than average costs (for example, in public transport) or in the presence of environmental spillovers too complex to be easily compensated by regulation (for example, in the case of water supply), I continue to believe public ownership to be preferable to private enterprise. But this view is not typical of Washington. Deregulation Another way of promoting competition is by deregulation. This was initiated within the United States by the Carter administration and carried forward by the Reagan administration. It is generally judged to have been successful within the United States, and it is generally assumed that it could bring similar benefits to other countries. The potential payoff from deregulation would seem to be much greater in Latin America, to judge from the assessment in Balassa et al. (1986, 130):
Property Rights In the United States property rights are so well entrenched that their fundamental importance for the satisfactory operation of the capitalist system is easily overlooked. I suspect, however, that when Washington brings itself to think about the subject, there is general acceptance that property rights do indeed matter. There is also a general perception that property rights are highly insecure in Latin America (see, for example, Balassa et al. 1986, chapter 4). Washington's Practice Washington does not always practice what it preaches, as a moment's reflection on the most embarrassing subject mentioned above—corruption—will surely reveal. This paper was, after all, written during the weeks when a massive scandal at the US Department of Housing and Urban Development came to light—a case involving fraud and irresponsibility on a scale large enough to erode the credibility of Washington's preaching. That would be true, at least, if Washington's advice were a moral admonition to purity. But that is not in fact the way it is generally perceived. Rather, the advice is intended to further the self-interest of the countries to whom it is directed (although not necessarily with a weighting of the interests of the constituent classes identical to that of the ruling elite in those countries). The fact that the United States also suffers from fraud and corruption does not make those practices any less detrimental in Latin countries, especially to those excluded from the elite. On the contrary, the greater pervasiveness of corruption in many Latin countries suggests that the damage it does is much greater. Washington's record is likewise imperfect in other areas discussed above. On the first criterion, that of controlling the fiscal deficit, the US record of the 1980s is poor. It is true that the federal deficit has been failing since 1985, especially as a proportion of GNP, and that the operational deficit is now only some I percent of GNP, which is within the range consistent with continued solvency of the public sector. However, the fiscal deficit remains too large for macroeconomic balance, given the low private saving rate in the United States. The excessively high fiscal deficit results in the maintenance of high real interest rates and an unsustainably large current account deficit, with consequential burdens on debtors, discouragement of investment, nurturing of protectionist sentiment, and the continuing threat of a "hard landing." The other areas where Washington's practice leaves much to be desired are exchange rate policy, where the ill effects of the dollar's vast overvaluation of the mid-1980s still linger even though the misalignment itself has been largely corrected, and trade policy, which has made discouraging lurches toward protection despite all the pledges to the contrary. in most of the microeconomic areas—notably tax reform, FDI (so far, at least), deregulation, and property rights—Washington's actions are consistent with its rhetoric. Concluding Remarks The economic policies that Washington urges on the rest of the world may be summarized as prudent macroeconomic policies, outward orientation, and free-market capitalism. It practices the last of these with more consistency than the first two, but that should not be taken to imply that they are less important. Most of technocratic Washington believes that the failure to practice what is preached hurts the United States as well as the rest of the world. It is not at all clear that the policy reforms currently sought by Washington adequately address all of the critical current problems of Latin America. Consider, for example, the transitional problems of inflation stabilization. Fiscal discipline is certainly a precondition for mastering inflation. But some would argue that it needs to be supplemented by price and wage freezes and a fixed exchange rate (on the Mexican model), whereas others might well wish to add price liberalization to the list of policy initiatives that Washington should be urging on Latin America. There is no consensus view on this topic, even though some policy on price control (perhaps differing by country) may be critical to successful stabilization. As a second example, Dornbusch (1989a) has recently raised the question of whether the Washington agenda described above can be relied on to restore growth once stabilization has been achieved. He points to the disappointing experiences of Bolivia and Mexico, where determined and effective stabilization has not yet resulted in a resumption of growth. If he is right in his contention that entrepreneurs may adopt a wait-and-see policy after stabilization rather than promptly committing themselves to the risks involved in new investment, the important question arises as to what must be added to Washington's policy advice in order to restore growth. A third important issue concerns capital flight. Fiscal discipline, positive real interest rates, a competitive exchange rate, and more secure property rights are all important for reversing capital flight. But it is doubtful whether all those reforms together would lead to a prompt return of flight capital. Elimination of the current tax incentive to keep money abroad would surely help too (Lessard and Williamson 1987), but this is certainly not a policy on which Washington has yet reached a consensus, nor is it clear that adding it would be enough to do the trick.4 Even though the Washington consensus may not be sufficient to resolve all the major Latin problems, it is surely of interest to ask:
Those are the questions that the country studies are being asked to address. Answering them will at least help to clear the ground for examining what additional policies may be needed to limit the transitional costs of inflation stabilization, to restore growth, and to reverse capital flight. One final reflection: A striking fact about the list of policies on which Washington does have a collective view is that they all stem from classical mainstream economic theory, at least if one is allowed to count Keynes as a classic by now. None of the ideas spawned by the development literature—such as the big push, balanced or unbalanced growth, surplus labor, or even the two-gap model—plays any essential role in motivating the Washington consensus (although I would fortify my preference for varying the pace of import liberalization depending on the availability of foreign exchange by appeal to the two-gap model). This raises the question as to whether Washington is correct in its implicit dismissal of the development literature as a diversion from the harsh realities of the dismal science.5 Or is the Washington consensus, or my interpretation of it, missing something? References Belassa, Bela, Gerado M. Bueno, Pedo-Pablo Kuczynski, and Mario Henrique Simonsen. 1986. Toward Renewed Economic Growth in Latin America. Mexico City: El Colégio de Mexico; Rio de Janeiro: Fundação Getúlio Vargas. Washington: Institute for International Economics. Brecher, Richard A., and Carlos F. Díaz Alejandro. 1977. "Tariffs, Foreign Capital, and Immiserizing Growth." Journal of International Economics (November). Cornia, Giovanni Andrea, Richard Jolly, and Frances Stewart. 1987. Adjustment with a Human Face. Oxford: Clarendon Press on behalf of UNICEF. Dornbrusch, Rudiger, and Sebastian Edwards. 1989. "Macroeconomic Populism in Latin America." NBER Working Paper 2986. Cambridge, MA: National Bureau of Economic Research. Lessard, Donard R., and John Williamson, eds. 1987. Capital Flight and Third World Debt. Washington: Institute for International Economics. Paredes, Carlos. 1989. " Exchange Rate Regimes, the Real Exchange Rate, and Export Performance in Latin America." Washington: Brookings Institution. Polak, Jacques J. 1989. Financial Policies and Development. Paris: Organization for Economic Cooperation and Development. Shleifer, Andrei. 1989. "Preconditions Necessary for the Recover of Latin America's Growth." Presented at a conference on The Economic Reconstruction of Latin America at the Fundação Getúlio Vargas, Rio de Janeiro (7-8 August). Tanzi, Vito. 1989. "Fiscal Policy and Economic Restructuring in Latin America." Presented at a conference on The Economic Reconstruction of Latin America at the Fundação Getúlio Vargas, Rio de Janeiro (7-8 August). Williamson, John. 1985. The Exchange Rate System. Policy Analyses in International Economics 5. Washington: Institute for International Economics. Notes 1. This figure assumes a desire to stabilize the debt-GNP ratio, D/Y, at no more than 0.4. Assume a real growth rate, ?Y/Y, of 0.04. Then ?D/D – ?Y/Y < 0 implies ?D/Y < Y/Y x D/Y = 0.04 x 0.4 = 0.016. 2. See, for example, Camdessus' address to the United Nations Economic and Social Council in Geneva on 26 June 1987 (IMF Survey, 29 June 1987) and the interview with Conable in Istanbul on 19 May 1989. 3. An exception to the case for welcoming FDI can arise if the domestic market in question is heavily protected, when the growth produced by foreign investment can be immiserizing: see Brecher and Díaz Alejandro (1977). 4. Some might want to add the debt issue as a fourth topic on which it is not clear that the Washington agenda suffices to resolve the current problem, but this seems to me unfair. The Brady Plan is based on the premise that official help in achieving debt reduction should be given to those countries that have "put their houses in order," which implies that the latter alone is not expected to achieve a resolution of the debt problem. 5. Ironically, Washington seems to have reached this position just as Chicago theorists have rediscovered the old ideas of externalities that underlay the development literature: see Shleifer (1989) for a survey of the new literature on the theory of development. |
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Neoliberal system and ESG
It remains maddeningly difficult to convince people of the innate self-destructiveness of ‘free market’ or ‘neoliberal’ culture, which makes it the main engine of our unsustainable behaviour.
Not only does this dynamic overwhelm the efforts of ‘market-led environmentalism’, it increasingly turns such efforts into reinforcements of the problem! This is counter-intuitive but systemically clear.
Neoliberalism is self-destructive as a social form because of its central paradox:
- Belief in the superiority of markets over non-market institutions cultivates an antipathy to government ‘intervention’…
- yet claims that markets are superior allocative institutions, depend on markets being ‘complete’…
- and it is only government, as an extra-market institution, that can force the internalisation of negative externalities to move markets towards the completeness that is the basis for their claim of superiority!
More succinctly: the paradox is that when negative externalities like climate change arise, "markets need government intervention to be made efficient!"
And because ‘negative externality’ means ‘a real cost that markets ignore’, the process of making markets more ‘complete’ necessarily involves government making a cost real in some form or other (tax, ban etc.)
But a ‘free market’ culture that has run for any length of time will have produced norms and formal powers that allow market participants to resist corrective action by governments. Hence, negative externalities will accumulate, and the ‘free market’ culture will gradually become a runaway ‘doom loop’, taking society and ecology with it. The market’s current propulsion of planet-warming AI epitomises this perfectly.
Alas, the neoliberal paradox repeats at sub-scale in the form of the 'ESG paradox'.
The belief of the ‘ESG’ or ‘win-win / green growth' movement is that markets might deliver solutions without the need to price or limit e.g. GHG emissions., i.e. the belief that markets might self-regulate without any need for external ‘regulation’. Sometimes this can work, but it is plainly not for climate change. GHG emissions reached new highs.
The problem with persisting with failing ‘market-led sustainability’ efforts is that underneath the details of such efforts, the greater part of what they do is reinforce the already strong cultural bias against government interventions that might harm corporate profits. In helping defend the background norm that governments should not act in ways that impair corporate profit, the ESG community does a large measure of the fossil fuel industry’s work for them.
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Do you want to know more?
| How the world became rich? |
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| Mark Koyama and Jared Rubin dive into the many theories of why modern economic growth happened when and where it did. They discuss recently advanced theories rooted in geography, politics, culture, demography, and colonialism. Pieces of each of these theories help explain key events on the path to modern riches. Why did the Industrial Revolution begin in 18th-century Britain? Why did some European countries, the US, and Japan catch up in the 19th century? Why did it take until the late 20th and 21st centuries for other countries? |
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