The Post-Washington Consensus

Link: http://www.foreignaffairs.com/articles/67456/nancy-birdsall-and-francis-fukuyama/the-post-washington-consensus?page=show

The last time a global depression originated in the United States, the impact was devastating not only for the world economy but for world politics as well. The Great Depression set the stage for a shift away from strict monetarism and laissez-faire policies toward Keynesian demand management. More important, for many it delegitimized the capitalist system itself, paving the way for the rise of radical and antiliberal movements around the world.

• Contrast between Great Depression's affect on world economy and current financial depression
• Other countries blame the U.S. for current financial crisis
• The current financial crisis is an indictment of the U.S. system of "the free-market or neoliberal model, which emphasizes a small state, deregulation, private ownership, and low taxes"
• Smaller countries maintained large amounts of foreign currencies and had regulatory control of financial system
• This, in turn, made them more resilient in the face of global economic problems; they rebounded faster after crisis
• "The crisis underscored the instability inherent in capitalist systems—even ones as sophisticated as the United States."
• The American capitalism model has been significantly weakened
• Developing countries trading advantages of free-market model for more resilient economy
• More concern with minimization of social disruption, by supporting social programs
• Less deference to developed countries; power becoming more distributed

• Pre-crisis assumption: foreign capital mobility led to substantial benefits
• Benefits of free trade: well documented
• Benefits of capital mobility: not proven
• Reason: financial sector vs. real economy
• "Free capital markets can indeed allocate capital efficiently. But large interconnected financial institutions can also take risks that impose huge negative externalities on the rest of the economy in a way that large manufacturing firms cannot."
• America, Britain learning what East Asia learned in 90s: free capital markets plus unregulated financial sector leads to disaster
• "At the conclusion of the Asian financial crisis, many U.S. policymakers and economists... overlooked the relevance of their new message to their own case, failing to warn against the danger of the huge, unregulated, and overleveraged shadow financial sector that had emerged in the United States."
• Financial crisis has led to end of assumption that foreign capital mobility is good thing (those who bought into this assumption the most are in the deepest - Ireland, Iceland, eastern Europe)
• "Just as for Wall Street, the strong growth records these countries amassed from 2002 to 2007 proved to be partly a mirage, reflecting the easy availability of credit and high leverage ratios rather than strong fundamentals."

• Financial crisis has also led to emphasis on social programs/policy
• Reagan/Thatcher: elected by attacking social programs/welfare state
• Capitalism: dynamic and unstable, produces faultless victims, needs level of social protection
• Western Europe: faced less painful recovery, had social protections/programs in place
• "American-style capitalism has fallen from its pedestal."
• China: focus on social policy, government building pension system, shift away from traditional approach of focusing solely on generating jobs
• Latin America: after 1990's crisis, move toward more social spending, reduction of economic inequality
• Brazil, Mexico: introduced cash transfer schemes targeted at poor; led to first visible declines in income inequality in years, and insulation of households from crisis
• Questions:
  • support from middle-classes?
  • management of costs?

• Financial crisis has led to new discussions about industrial policy
• Development of specific industrial sectors
  • Traditionally: cheap credit, subsidies, state management
  • 1980s, 1990s: failures, supported inefficient industries at high cost
  • Crisis and response: proof that state management can work
  • Brazil: government-sponsored bank to target credit at sectors (stimulus program)
  • China: state-run banks " " " " " ( " " )
• Trying to address barriers discouraging private investment in these industries
• Governments can help industry by providing infrastructure, or bearing financial risk
• "For the last three decades, Washington-based development institutions have taken the view that growth is threatened more by government incompetence and corruption than by market failures. Now that American-style capitalism has fallen from its pedestal, might this view begin to shift? Might the idea that the state can take a more active role get far more traction?"
• Shift away from American capitalism model may lead to increasing state involvement in industries
• But big argument against this is not economic, it is political
• Policymakers keep protective measures in place after they are needed
• East Asia/Latin America: political inability to remove protections led to industries failing globally

• Financial crisis has demonstrated cost of not reforming public sector (U.S. example: regulatory agencies facing budget cuts, lack of good personnel, political opposition...)
• "If countries are to promote industrial development and provide a social safety net, they will need to reform their public sectors; indeed, the fourth consequence of the crisis has been a painful reminder of the costs of not doing so. In the United States, regulatory agencies were underfunded, had difficulty attracting high-quality personnel, and faced political opposition. This was not surprising: implicit in the Reagan-Thatcher doctrine was the belief that markets were an acceptable substitute for efficient government. The crisis demonstrated that unregulated or poorly regulated markets can produce extraordinary costs."
• China: capable of bouncing back from crisis by avoiding delays of democratic processes, competent management of complex policies
• China is exception to the rule
• Seeing China's example has led developing world to associate autocratic systems with efficiency
• Promotion of efficient public sectors is difficult; case in point: U.S. and Britain failed at it
• Why does this fail?
  • Bureaucracies serve governments composed of coalitions acting according to self-interest
  • Institutions can only be effective by growing locally/domestically and reflecting local/domestic politics; people in a society must buy in to it
  • Analogous to nation-building; without a nation, you can't nation build, and likewise without a nation you can't reform public institutions; otherwise people show more loyalty to their tribe/network

• Financial crisis may signal end of American economic dominance
• But trend is not new
• Post-WWII institutions (World Bank, IMF, Bretton Woods) suffered, needed reform, didn't grant much power to developing countries
• G7 is another example: developed Western deomcratic countries plus Japan steering global economics, ignoring new/emerging power centers
• Decline of G7, rise of G20
• Shift in development agenda
  • Traditionally: created by developed countries, imposed on developing countries
  • More new ideas coming out of developing countries (e.g. conditional cash transfer schemes, successful models for industrial policy, etc)
• Increasing role of developing countries in implementation and receipt of new resources