Bolivian President Gonzalo Sanchez de Lozada faced a quandary. The International Monetary Fund wanted his country, one of the poorest in the world, to cut its budget deficit from 8.75 percent of GDP to 5.5 percent. At stake was desperately needed Fund aid. Feeling he had no recourse, Sanchez de Lozada announced a 12.5 percent income tax in February on all workers earning more than $130 a month.
Ordinary Bolivians, fed up with decades of IMF-imposed belt-tightening, had had enough. As thousands took to the streets of La Paz to protest the tax, demonstrations turned violent. Policemen, angry that the government was ignoring their request for a 40 percent pay hike, joined the protesters, and gun battles broke out between the police and the military. Nearly 30 people were killed, and more than 200 wounded. Crowds stormed government offices and stoned the presidential palace. Sanchez de Lozada had to be whisked to safety in a bullet-riddled ambulance.
Facing the collapse of his government, the president abandoned the tax scheme and appealed for emergency foreign aid. The U.S. and others chipped in. The IMF soon relented. In April it agreed to give Bolivia a one-year, $118 million loan, provided La Paz reduced its budget deficit to 6.5 percent rather than the original 5.5 percent.
“After people died the IMF became more understanding,” says Nancy Birdsall, former executive vice president of the Inter-American Development Bank and now president of the Washington-based Center for Global Development. “Pressuring a reformist government to change wasn’t wise.”
No, but that was often the modus operandi of the IMF and the World Bank in recent years as they sought to spread the gospel of free markets, privatization and fiscal responsibility that came to be known as the Washington consensus. What has been the result? To an increasingly loud chorus of critics, the answer is simple: Not nearly enough economic progress.
During the 1990s annual per capita income fell 1.9 percent in Central and Eastern Europe and 0.4 percent in sub-Saharan Africa. And the proportion of people living on less than the equivalent of $1 a day increased in Latin America, the Middle East and North Africa (by 0.1 percent each), sub-Saharan Africa (1.6 percent) and Central and Eastern Europe (13.5 percent). In the 1990s, 54 countries slipped back on the human development scale, as measured by the United Nations Development Program; just four regressed in the 1980s.
“The Washington consensus is broken,” proclaims über investor-turned-philanthropist George Soros. Its policy prescriptions first came under sustained attack after the Asian financial crisis of 1997'98, when the IMF was accused of worsening the emergency by imposing draconian budget cuts and excessive structural reforms on the region’s ravaged economies. The IMF and the World Bank responded in jury-rigged fashion by expanding on the old policies to include social policies, such as health and education programs, and institutional reforms to root out corruption and promote good governance.
But the development banks’ so-called augmented consensus has also come under fire. “There is no evidence of the augmented consensus working anywhere,” says Harvard University economist Dani Rodrik. “As each set of Washington consensus ideas proves disappointing, we do a patch-up operation of what else needs to be done.”
Getting development right is critical. Poverty and inequality breed discontent and, at the extreme, terror. Globalization itself could hang in the balance. After all, Washington-consensus-style reforms were intended to integrate developing countries into the world economy.
What will come next? This is the basis of an urgent and increasingly pitched debate among bankers, investors, academics, government leaders and officials of the big multilateral aid institutions. What is emerging is not one development model but a variety: blueprints that incorporate many of the precepts of the original consensus but gear them specifically to the needs, cultures and tolerances of individual countries while showing greater sensitivity to local social and political concerns.
“We should be more resourceful and opportunistic in implementing development instead of remaining encased in the dogmas of the past,” contends José María Figueres, a former president of Costa Rica and current managing director of the Center for the Global Agenda at the World Economic Forum in Davos, Switzerland. “Times are right to shift the paradigm of development from economics to one that embraces human development.”
Such a shift poses a serious head-on challenge to the IMF and the World Bank, which have come under attack from both ends of the political spectrum. Leftists pillory the Bretton Woods pair for having blindly imposed rigid free-market policies on poor countries, whereas critics on the right carp about tens of billions of dollars wasted on bailouts and failed aid packages.
Today the IMF and the World Bank face increasing defiance from another crucial constituency: developing countries around the world. (It doesn’t help that the Washington consensus is so closely associated with the U.S. at a time of growing anti-American sentiment.) They challenge the very structures of those institutions. Why, the critics ask, do emerging countries have so small a voice in organizations supposedly dedicated to their interests? Forty-four African countries are represented in the Bank today by just two executive directors out of 24 and exercise slightly more than 5 percent of the vote. France, Germany, Japan, the U.K. and the U.S., meanwhile, each hold a seat on the board and collectively wield 37 percent of the vote. The U.S. alone has veto power.
“It doesn’t make sense to maintain the status quo when the legitimacy of the IMF and the World Bank is being increasingly questioned,” says Ariel Buira, a former Mexican diplomat who served as an IMF executive director in the late 1970s and early ‘80s and was his country’s special representative to the United Nations summit on global development in Monterrey, Mexico, in March 2002.
Leading Group of Seven figures and development bank officials are quick to defend the adaptability of their policies and, in some cases, to distance themselves from the very term “Washington consensus.” Says John Taylor, undersecretary of international affairs at the U.S. Treasury Department: “To me it is clear that good, solid economic policies that promote economic freedom work, but ‘the Washington consensus’ is a term that is imprecise, because it doesn’t mention those policies and refers more to macro policies and not to micro policies. To the extent that it is used this way, I think it is incomplete and was incomplete.”
Taylor vehemently rejects the charge that development policies are applied indiscriminately to countries. “There are many different ways to have more efficient regulation,” he points out. “There are many different ways to provide public goods. I don’t think it is a one-size-fits-all policy.”
World Bank president James Wolfensohn prides himself on having tried to move the Bank away from the Washington consensus toward a broader view of development. In a recent interview with Institutional Investor, he cited the Bank’s Comprehensive Development Framework as an attempt to integrate economic, social and environmental aspects of development policy.
“I have been talking about corruption for eight years,” says Wolfensohn. “I have been talking about institutions for eight years, I have been talking about one size does not fit all for eight years, I have been talking about the Washington consensus not being relevant for eight years, and I’ve been talking about developing models for each country.”
That’s a lot of talk. What developing countries want is a successful plan of action, and increasingly, they’re taking matters into their own hands. In July, Thailand’s prime minister, Thaksin Shinawatra, almost gleefully prepaid the last portion of the $4 billion his country borrowed from the IMF during the Asian financial crisis. Thais, he vowed, would never again “fall prey” to IMF diktats or the forces of foreign capital.
Indonesia, too, has said it won’t seek further assistance from the IMF when its current $5 billion loan program expires later this year. Indonesians are still smarting over onerous structural reforms forced on them by the IMF during the Asia crisis -- and symbolized by a photo of thenIMF managing director Michel Camdessus standing cross-armed over then-president Suharto as he signed up for the IMF program.
Argentinean President Néstor Kirchner has also been standing up to the IMF. His country, once deemed a Washington consensus success story, collapsed into depression and political chaos after defaulting on its debt in December 2001. Kirchner has imposed capital controls, refused to lift a moratorium on mortgage loan foreclosures, slapped price controls on private utilities and declined to bail out banks. Ordinarily, such actions would be anathema to the IMF. Nonetheless, the agency is now negotiating a three-year loan to replace short-term financing that rolled over $7 billion of Argentina’s outstanding IMF debt. “This program is definitely owned by Argentina,” says Christian Stracke, head of emerging-markets research for CreditSights, an independent research firm in New York.
Brazil, historically one of Latin America’s most prodigal borrowers, has embarked on a less confrontational but potentially more revolutionary course. Along with surprisingly conservative macroeconomic measures, leftist President Luiz Inácio Lula da Silva is emphasizing social policy, supporting land reform and seeking -- through his Fome Zero (Zero Hunger) program -- to provide food to all who need it (see page 25).
“Lula has been choosing his own reforms and is investing in people,” says the World Bank’s chief economist, Nicholas Stern, who joins the U.K. Treasury as managing director for budget and public finance this month. “He has taught us not to be dogmatic.”
Indeed, Brazil’s moderate-left experiment could well define the broad development agenda postWashington consensus. “If Brazil goes down, it undermines the whole [IMF and World Bank] strategy in Latin America,” contends Nobel Prize winner and former World Bank chief economist Joseph Stiglitz. “If a moderate with a social agenda like Lula cannot succeed, the view is that this would radicalize Latin America. People will say, ‘We tried the right, we tried the moderate left -- what remains?” Notes Costa Rica’s Figueres: “We have a moral and vested interest in Brazil being successful. It could signal a new road in terms of optimism and hope for Latin America.”
To be sure, not everyone pronounces the Washington consensus an utter failure. Austerity and macroeconomic stabilization policies made good sense for developing countries racked by hyperinflation and deep in debt during the 1980s. “The Washington consensus did some good things,” says United Nations Development Program administrator Mark Malloch Brown, an exWorld Bank vice president. But he adds that “people stuck with it too long -- it has become a straitjacket.”
In place of that straitjacket, developing countries are slipping on coats of many colors as they adopt the view that no single fixed recipe for growth exists. More and more countries are likely to experiment with economic policies as they grope for their own paths to prosperity.
“The error of multilateral agencies is to think that [rigid] development models work everywhere,” says Brazilian Finance Minister Antônio Palocci. Adds Harvard economist Rodrik, a leading advocate of letting countries experiment to find the mix of policies that work best for them, “This will be a race between evidence and ideology, and evidence will win out, especially if we have positive cases.”
Economists and policymakers fear that if the more moderate, market-based efforts like Brazil’s come up short, there’s a real risk that struggling countries will succumb to the nationalist and populist policies -- and class warfare -- of a Hugo Chávez.
“If Lula fails, what else is there but Chávez?” asks John Williamson, the economist for Washington’s Institute for International Economics who coined the phrase “Washington consensus” in 1989.
EVEN BEFORE IT HAD A NAME, THE WASHINGTON consensus was generating controversy. The U.S.-inspired set of ironclad policy prescriptions, as identified by Williamson, consisted of ten core tenets: fiscal discipline, reorientation of public expenditures toward sectors that provide higher economic returns, tax reform, interest rate liberalization, unified and competitive exchange rates, trade liberalization, openness to foreign direct investment, privatization, deregulation and secure property rights. Applying the consensus, the IMF sought to foster fiscal discipline, promote trade liberalization and encourage privatization and deregulation to help countries stabilize their economies and repay foreign debt. The Fund also encouraged them to open their borders to capital flows, both inward and outward. Tacked on to the consensus as an implicit codicil was a mandate to shrink the role of the state.
Critics on the left, like Michael Manley, prime minister of Jamaica from 1972 to 1980 and from 1989 to 1992, objected from the beginning to the consensus’ unwavering reliance on free markets and to its resort to often harsh budget cuts to restore countries’ fiscal health. But long-standing complaints about the consensus became more intense and broader based following the Asian financial crisis. Leftists lambasted the IMF and the World Bank for encouraging Asian countries to warmly welcome foreign capital, helping to generate a bubble, and then forcing those same countries to cut spending too sharply once that bubble burst, making their predicament even worse. The Fund countered that once it realized that its original austerity measures were indeed too severe -- particularly in Thailand and Indonesia -- it permitted them to run up larger budget deficits.
Critics on the right, like Carnegie Mellon University economics professor Allan Meltzer, who in 2000 headed a U.S. congressional commission on reforming the IMF and other international financial institutions, pointed to the costs to U.S. and other developed-country taxpayers of repeated bailout packages that did so little to stem the recurring crises. The Asia episode was soon followed by crises in Latin America. Most conspicuously, Argentina effectively imploded.
Countries that tried hardest to adhere to the Washington consensus -- mainly those in Latin America -- seemed to do worse than those that took a less doctrinaire approach. This helps to explain the success of China and India. China created a two-track economy by imposing a free-market overlay on an essentially state-run economy. India adopted a gradualist approach to reform and, like China, did not fully liberalize its financial sector. Even putative free-market paradigm Chile retained government control of copper, its most important export, preserved capital controls and used industrial policy to develop agribusiness (see page 32).
“The Washington consensus said fiscal balance, reduction in inflation and equilibrium in accounts would bring economic growth,” says Brazil’s Palocci, a key member of Lula’s cabinet. “Various countries tested this model, and a good part of them achieved equilibrium but did not get growth. Macroeconomic equilibrium is for us a means, not an end. It is a presupposition for growth, not a guarantee of growth.”
The World Bank’s Wolfensohn argues that the policy changes made by developing countries are not enough to ensure growth on their own. “Absolutely crucial” to their success, he says, “is what happens in trade, what happens on the issue of [developed-country] agricultural subsidies.”
At the Monterrey summit, for example, the U.S. and Europe pledged to lower de facto trade barriers to foreign farm goods by reducing their lavish subsidies to domestic farmers as a way to induce developing countries to open their own markets. But little progress has been made on either side.
Wolfensohn points the finger of blame at the rich countries and away from the World Bank. “You have $50 billion in some form or another going to foreign aid, but you have $300 billion-plus spent on agricultural subsidies and you have $900 billion spent on defense -- and it is that fundamental imbalance that needs to be addressed over the coming years if you are going to see 5 billion poor people catching up,” he says.
Tellingly, the debate over the Washington consensus is no longer about whether its conditions are sufficient in and of themselves to promote growth but whether they are even necessary to do so. “The ‘sufficiency’ part of the Washington consensus started fraying five years ago, after the Asian financial crisis,” says former World Bank chief economist Stiglitz. “Now we are beginning to see the fraying of the ‘necessity’ part of the Washington consensus.” For instance, he says, a country might be able to live with higher inflation than the consensus would normally tolerate to avoid having to raise interest rates and cramp growth.
For their part, the World Bank and the IMF sought to stem criticism of the consensus by adding to the original ten rules. The augmented consensus includes a focus on “ownership” (countries are encouraged to feel proprietary about reforms), good governance and institution building (establishing an independent central bank, corruption-free courts, efficient regulatory agencies, etc.). “The problem is that the original consensus left out areas of fundamental importance,” says World Bank chief economist Stern. “There was nothing about the centrality of institutions, governance and behavior or about the social costs of adjustment or country ownership. These are not add-ons, these are fundamentals.”
Former Canadian Finance minister Paul Martin, currently a member of Parliament, concurs: “Liberal economic reforms work. We have to round off the hard edges, and this is where criticism of the Washington consensus comes in -- the narrow interpretation of the Washington consensus has become stale, dated.”
The advent of the augmented consensus has led to modest changes at the IMF and the World Bank. The latter has been reexamining industrial policy and land reform. “If you do macroeconomic adjustments within a country where inequality prevails, the danger is that you will increase that inequality,” says Steen Jorgensen, the Bank’s director for social development. “We need to look at policies like land reform. We’re going back to old-fashioned development -- all the things that were lost in the rush to get the macro framework right.” The Bank now wants its loan programs to specifically promote social equity.
The Bank has also been rethinking infrastructure privatizations. In March it issued a report asserting -- remarkably, from a Washington consensus perspective -- that private ownership was not a panacea. As an example, it cited Bolivia’s having to cancel a water concession in Cochabamba that was run by a multinational consortium after rate increases triggered violent protests. The issue of who is to pay for infrastructure services, such as water, sanitation and electricity, remains a contentious one. “There is a lot of soul-searching and less optimism about the speed and pace of reform, because governments haven’t dealt with the [infrastructure services] pricing issue,” says Michael Klein, the Bank’s vice president for private sector development.
In March, IMF chief economist Kenneth Rogoff released a study concluding that the Washington consensus credo that allowing foreign capital to freely enter and exit countries would invariably lead to stability and growth was misguided. Such an admission would have been unthinkable six years ago. At that time, thenmanaging director Camdessus was trying to change the IMF’s articles of agreement so that it could force countries to open up their capital accounts. “Rogoff’s paper is a key capitulation,” says Stiglitz. Adds the Center for Global Development’s Birdsall: “Changing the IMF is a slow process. The staff is there forever, and it is a hierarchical institution. The fact that Rogoff put out that paper is very important, because it helps to convince the staff analytically.”
Rogoff himself denies that the paper signals a major shift and cites IMF studies dating to the early 1990s that purport to demonstrate that liberalizing capital flows can be problematic. “It is hard to see what’s so remarkably new,” says the economist, who returns to Harvard University this month to head up the Harvard Center for International Development. “The lesson of the Asian crisis is that capital-account liberalization should come late in the game.”
Now the augmented Washington consensus threatens to collapse under its own weight. “The tendency has been to add on to the consensus agenda rather than take a critical look at it,” says Harvard’s Rodrik. The result, he says, is to overburden countries with too ambitious an agenda of reforms. Bolivia, in return for its most recent IMF loan, was told to eliminate five government ministries, set up a special government unit to fight corruption, draft new bankruptcy laws and strengthen tax agencies’ enforcement powers (the last two provisions require congressional approval).
Some critics complain that the multilaterals’ reform agenda can also, paradoxically, be too narrow. A Group of 24 study of 13 sub-Saharan African countries receiving IMF loans in 1999 and 2000 found that on average they had to meet 114 conditions, 82 of which were governance-related. “The new Washington pseudoconsensus focuses on institutions as the key, so institution building is the new mantra,” says longtime developing-country adviser Jeffrey Sachs, director of Columbia University’s Earth Institute and special adviser on poverty alleviation to Kofi Annan, secretary general of the United Nations. “But institutions are not everything. In the poorest countries institution building still ignores disease, hunger, environment, lack of infrastructure and so on.”
The caring posture of the augmented consensus can seem phony in the capitals of the smaller developing countries. Big borrowers, such as Brazil, Argentina and Turkey, have more leverage with the IMF and the World Bank than smaller borrowers, like Bolivia. The Fund hasn’t shown the same sensitivity to such countries’ need to build a domestic political consensus behind reforms. Big-country bias is, in fact, built into the very fabric of the Fund and the Bank, reflecting the balance of global power at the time the pair were created in 1944. Votes were apportioned according to the size of countries’ economies and their contribution to the agencies’ budgets.
Washington opposes a change in voting shares at either the Bank or the Fund. As Carole Brookins, the U.S. executive director at the Bank, wrote in a confidential note to the Bank’s board in June: “The increase in developing countries’ share of votes . . . would not be material [because of the informal custom of making decisions on a consensus basis], would do more harm than good and, in our view, would be inconsistent with the principle that country shares in the IFIs [international financial institutions] should reflect relative economic weights in the world economy. Giving population and other factors a weight in voting strength would create a radically different, less desirable and nonfinancial structure for the Bank.”
Many developing countries are disappointed by Washington’s attitude, saying that it runs contrary to the spirit of last year’s Monterrey summit. President George W. Bush and other developed-country leaders had vowed to give developing countries a greater say in development issues. “It seems rather serious that commitments made at the heads-of-state level at the Monterrey summit have been pushed aside,” says Mexico’s Buira. The U.S. Treasury’s Taylor says Washington wouldn’t object if regions that are now overrepresented, such as Europe, gave up their seats to Asian or African countries, but that doesn’t seem likely.
Expanded voting rights could increase developing countries’ sense of having a stake in the Fund and the Bank. “Reform is so much easier when countries feel that they are participants and setting the agenda at the institutional level,” reasons Birdsall. “It affects whether conditionality is realistic [and] politically sensible and offsets resistance. [The current regime] is a great deal for the U.S. -- cheap leverage over the international financial institutions.”
Developing countries complain, too, that the IMF imposes budget constraints on them that make it difficult to address social problems, the more accommodating augmented consensus notwithstanding. “The IMF puts us in a straitjacket,” says World Bank executive director Paolo Gomes, who represents 24 mostly francophone African countries. “We see an incompatibility between the World Bank’s poverty reduction planning process and the IMF’s macroeconomic framework.”
What developing countries really need, Gomes says, is room to develop their own agendas. “There is no secret that we have to be careful about public finances and monetary policy, but we have to be sure that short-term thinking doesn’t kill off imagination about long-term development,” says the Guinea-Bissau native. “The IMF doesn’t give developing countries enough space to think about the long term.”
The Fund has little official sympathy for complaints of this sort. “Space constraints really come from the market,” says IMF chief economist Rogoff. “We strongly support increasing aid, but the reason countries that come to the IMF face spending constraints is because they borrowed too much.”
In challenging the Washington consensus, developing nations are also questioning another of its fundamental credos: free trade. Sub-Saharan Africa’s share of international trade actually declined during the 1990s, even though it grew in absolute terms. “Maybe international integration is just a dream,” muses Gomes. “With all the rich-country protectionism, there is no way we can compete.” He proposes that the African states “create regional markets and produce the basic things we need where there is demand -- though this would require some protection.”
Talk of reinstating protectionism is naturally anathema to the Bank and the IMF. “If you protect one thing, you are penalizing something else, and you can’t penalize everything,” says the World Bank’s Stern.
Still, some see the case for reflexively liberalizing trade in poor countries as anything but clear-cut. “At low levels of national income, increased openness to trade is associated with higher levels of inequality,” notes World Bank research economist Branko Milanovic. “This is not an argument against globalization but an argument for domestic reforms, like investing in health, education and infrastructure to prevent inequality from increasing.”
Brazil is a test case of that very proposition. If the country can accomplish its welfare reforms without utterly disrupting its economy, it will encourage other countries to keep the core free-market faith even as they experiment with more expansive social policies and put a premium on growth over stability.
But are the IMF, the World Bank and the U.S. Treasury prepared to countenance such an approach?
So far the flexibility of the multilaterals and the U.S. has not been put to a true test. Despite his sometimes radical rhetoric, Brazilian President Lula has pursued fairly orthodox macroeconomic policies. For example, he increased spending on school lunches, but he did so by canceling contracts to buy fighter jets, not by running up a bigger budget deficit. “There has been no conflict yet in Brazil between social spending and macroeconomic stability,” notes Barry Eichengreen, an economics professor at the University of California, Berkeley. “But if Lula becomes more heterodox with budget deficits, that will test the IMF’s willingness to accommodate an expanded social agenda.”
The odds against Brazil run high. It needs to service a large foreign debt, so the country’s interest rates remain dauntingly high -- 22 percent for the benchmark Selic short-term rate -- putting a brake on growth and exacerbating poverty and income inequality. “Brazil is being forced into a very conservative monetary and fiscal policy because of its dependence on the foreign markets,” says investor-philanthropist Soros. “There is no incentive from the IMF for Brazil to grow faster, so Lula ends up with a sound economic policy, but one that doesn’t gratify the people who elected him.” Those unhappy people might then vote him out of office, ending Brazil’s brash experiment with market socialism.
Yet the U.S., the IMF and the World Bank remain wary of a growth-focused, as opposed to stability-focused, development policy.
“We need a development-oriented macroeconomic policy that can allow 8 percent inflation if that produces more growth,” contends former World Bank economist Stiglitz. But he acknowledges that such unconventional thinking is considered dangerous by the Washington development establishment.
Nevertheless, growing unease in developing countries that have seen little or no growth for a decade may force the Fund and the Bank and Washington itself to be less dogmatic and allow countries to help mold their own development models. Says Harvard’s Rodrik, “There has been a downgrading of aspirations among developing countries with respect to economic growth, but the current policies aren’t sustainable because of social unrest.” Adds Birdsall, “People are exhausted with reforms, and that makes it very difficult for governments” to impose further austerity measures.
But IMF, World Bank and U.S. Treasury officials aren’t the only ones who need to become more flexible; developing-country politicans must do so as well. As Rodrik notes: “The Washington consensus has an appeal that the alternatives don’t have: It tells you what to do. You don’t have to figure things out for yourself.” As more of the onus for formulating policy shifts to local politicians, the IMF won’t make so convenient a whipping boy.
THE WASHINGTON CONSENSUS is dead. Long live . . . what? The new model of development may turn out to be a number of models, perhaps one for each country. All, though, will aim for healthy growth, borrow liberally (but not rigidly) from the Washington consensus -- free trade, privatization and capital liberalization will no longer be absolutes -- and stress social welfare policies. The transition to this brave new third world, however, won’t be easy or painless.
“It is very hard for the World Bank and the IMF to have different policies for different countries,” cautions Costa Rica’s Figueres. “It is still going to take a lot of heavy lifting from the international financial institutions and from the developed countries to accept the new mind-set.”
