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Washington Consensus or development economics?

The body of work of former World Bank Chief Economist turned “rebel within” Joseph Stiglitz manifests not only trenchant opposition to Washington Consensus economic orthodoxy but also a fervent belief in participatory development strategies and in the democratic process. The force of his convictions comes across clearly in a recently published book which distills the speeches and writings of the Nobel laureate.

by Paul Rayment


The faith and fervour with which the Washington Consensus and the underlying neoliberal economic theory was promoted by the Bretton Woods institutions and willy nilly accepted and practised in developing countries received a rude shock in December 1994 (the Mexican peso crisis), and  in 1997 and 1998 (the Asian and Russian crises respectively).

“Consensus” is usually understood to mean a general agreement about something or at least the view of a very large majority, and is usually indicated by some voting or polling procedure. In the case of the Washington Consensus (hereafter WC), the term is used rhetorically, to persuade the audience that the positions asserted by the authors are much stronger than the evidence actually warrants.

After the Asian and Russian crises, the outburst of criticisms and challenges (from economists, governments, other international institutions and civil society) led  the International Monetary Fund and the World Bank seemingly to change or distance themselves from the WC.1

However, the crisis in Argentina and the responses to it suggest that little has in fact changed since the Asian and Russian crises - whether in the policies promoted by the IMF, World Bank and other international financial institutions and those who control them, or in the manner in which decisions are taken.

Breaking ranks with the establishment

Joseph Stiglitz, the latest Nobel laureate in economics, was appointed Chief Economist and Vice President of the World Bank in February 1997, a few months before the Asian financial crisis erupted with the floating of the Thai baht on 2 July.  By the end of the year Stiglitz had created a major scandal by attacking the IMF’s handling of the crisis, accusing it of faulty diagnosis of the problem and of making it worse by insisting on high interest rates and tight fiscal policies.  Although professional economists are still divided on the responsibility of the Fund for the severity of the crisis2, a great many of them would agree with Stiglitz’s criticism.  Moreover there is little doubt that the Fund’s handling of the crisis severely damaged its credibility and created considerable resentment in Asia by its insistence on reforms which had little to do with the restoration of market confidence.3

Stiglitz’s ‘crime’, however, was not so much what he said - the Fund was used to hearing and ignoring similar comment from academics and other outsiders - but that he had broken ranks as a senior member of the Washington establishment.  As the Financial Times put it later, in an editorial on 26 November 1999, the policy-makers in the IMF “inevitably found this carping criticism from the institution next door intolerable”.  The spin-doctors then went to work on a cooperative press:  we learned from anonymous Washington insiders that “Joe has a great mind but he’s not a team player”,  “he’s not an institutional person or an operational force in the Bank”, that (Michel) Camdessus (then Managing Director of the IMF) was insisting Stiglitz be put on a “short leash”, and so on and so forth.  World Bank President James Wolfensohn gave him half-hearted support, describing him as a “free spirit” and saying that he was “always interested to see what Joe is saying on behalf of the Bank”.  The message was clear:  don’t take Joe too seriously, even if he is the Bank’s Chief Economist and a Vice-President.  One almost expected to hear that he had been asked to retire alone to his office and do the honourable thing by the regiment.  However, after a brief moment of “unavailability”, when another Vice-President joked that “we tied him up and threw him in a padded cell”, Stiglitz carried on producing papers and delivering lectures and speeches until he stepped down from his post just before his contract was due to end in February 2000.

Whether he left of his own accord or was pushed by the US Treasury and the IMF is a question that will only be answered authoritatively when the memoirs appear or the archives are opened.  His departure was accompanied by crocodile tears from the Financial Times (26 November 1999) - if transparency and “informed public debate” become “a normal part of the way the World Bank and the IMF are run, then what is good in Mr. Stiglitz’s legacy will have been not just preserved but extended”.  But as for Stiglitz himself, unfortunately he was “a gadfly” and his criticism of the Fund was “carping”.  Jagdish Bhagwati (FT, 3 December 1999) condemned Wolfensohn for mismanagement in allowing Stiglitz to openly question IMF policies and disapproved of the Chief Economist’s “public behaviour”, but could “only rejoice” at Stiglitz’s return to scholarly research at Stanford.

Collection of papers and speeches

It is worth recalling the hot air that was generated by Stiglitz’s tenure at, and departure from, the World Bank because we can now look more carefully at what he was actually writing and saying at the time.  Ha-Joon Chang, of Cambridge University, has carefully chosen nine papers and speeches out of some 30 or more that Stiglitz delivered in the three years he was Chief Economist (Ha-Joon Chang (ed.), Joseph Stiglitz at the World Bank:  The Rebel Within, London: Anthem Press, 2001).  These include his WIDER and Prebisch lectures of 1998, which contain his critique of the WC and his proposals for a new strategic approach to development.  He then goes on to the role of the state (what it should do, how it should do it, and how decisions should be made), insisting that it has made a large, positive contribution to development not only in East Asia but also in the United States.  His review of the transition process in eastern Europe and the former Soviet Union is trenchant, some of his more withering criticism being directed at the array of Western advisers with “sure-fire recipes” who not only knew little of the countries they were advising but also understood poorly the economies from which they were coming.  The chapter on the role of the IMF focuses mainly on the causes of the 1997 Asian crisis and draws some lessons which might help to reduce the frequency and magnitude of similar crises in the future.

The remaining four chapters are in some ways the most interesting because they elucidate some of the key foundations of Stiglitz’s thinking and approach to economic development.  The economics of information and learning is one of the areas where he has made key contributions and for which he was awarded the Nobel Prize;  in the chapter “Scan Globally, Reinvent Locally” he argues that building autonomous learning capabilities is crucial for promoting both development and democracy.  The pretence that knowledge for development is basically universal and can be dispensed by a central authority, national or international, is not only a form of intellectual colonialism but is profoundly mistaken in its disregard of the importance of local and tacit knowledge in making innovations work.  The attempt to identify and transfer “best practices” from developed to developing and transition economies, an expanding activity in many international institutions where “best” is often no more than current corporate practice in North America or western Europe, suffers from the same misconceptions.

Stiglitz’s Oxford Amnesty Lecture of 1999 is a powerful attack on the pervasive secrecy in most government systems:  he insists that democracy implies a basic right to be informed about what government is doing and why, but transparency and openness also have instrumental value in reducing the likelihood of abuse of power and improving the quality of official decision-making. (The superiority of democracy and democratic process in solving problems and advancing knowledge was of course one of the key points made by Popper, drawing on a long tradition, in his The Open Society and Its Enemies.)

The final chapter, which Chang, in his useful and succinct introduction, describes as “a highly unusual piece of work even for someone like Stiglitz”, brings together some of the previous themes such as participation, the right to know and economic democracy, in an analysis of industrial relations.  He argues that a system based on worker participation and teamwork, implying high degrees of trust between managers and workers, can increase efficiency and make it easier to promote change and progress.  Stiglitz severely criticizes the way labour is treated in neoclassical theory.  Hidden within the assumptions of the competitive general equilibrium model are “sophisticated forms of madness”, and “if one didn’t know better, it might seem as if the fundamental propositions of neoclassical economics were designed to undermine the rights and position of labour”.

Chang’s selection of Stiglitz’s papers is very well done:  a wide range of issues is covered but they are linked by a number of unifying themes.  There is inevitably some overlap but this is not really a problem since it rather emphasizes the underlying interconnectedness between the various subjects.  Far from a “carping gadfly”, what we encounter in these papers is a humane and civilized man with a first-class intellect grappling with major issues in a coherent and consistent manner.

Attack on the Washington Consensus

Among the major themes of the book is Stiglitz’s attack on the WC.  He argues that it is too narrow in its objectives, confuses ends with means and, by ignoring other necessary conditions for development, is frequently counterproductive.  Thus, development is largely seen by the WC in terms of expanding GDP, but, even there, too much emphasis is placed on price stability rather than the steady growth of output;  trade liberalization and privatization are too frequently seen as ends in themselves rather than means to “sustainable, equitable and democratic growth”;  and the neglect of the institutional framework required to support effective markets has helped to intensify distortions rather than eliminate them and to hold back development and economic growth.  Many of the most successful cases of development among developing and transition economies are those where governments ignored all or much of the WC strategy.  The more basic problem is that the underlying economic theory of the WC has virtually nothing to say about the dynamics of economic development and transition;  it can say something about B but it cannot help you to get there from A.

Although the WC emerged as a policy brandname in 1990, the basic argument over development strategy goes back at least to the 1960s, and Stiglitz’s critique is largely shared by his predecessors such as Myrdal, Rosenstein-Rodan, Nurkse, Rostow, etc. (who are not referred to by Stiglitz) and Hirschman (who is).  The WC is essentially the policy outcrop of the neoclassical school, the supporters of which, although often acknowledging the importance of institutions, are basically optimistic that institutional and other obstacles to the reallocation of resources will not deter investment and sustained growth if only relative prices “are right” and private enterprise is given a free rein.  A lot of time-consuming institutional development can therefore be postponed to a later stage.  Myrdal and the other “structuralists” of the 1960s were highly sceptical about the spontaneity of the response to the “right prices”.  They argued that institutional and coordination failures would block or weaken the mechanism of reallocation, let alone the broader process of development.  They therefore saw a major role for government in building the institutional framework for a market economy and in getting the development process under way.  The successful development of the East Asian economies from the early 1970s - and Stiglitz rightly insists (Chapter 5) that this is not vitiated by the 1997 crisis - essentially followed the approach suggested by Myrdal et al. rather than the neoclassicals.4 

Stiglitz shares the views of these early sceptics about spontaneous adjustment to the “right prices”, and he highlights the inadequacies of the general equilibrium model in understanding how market economies actually work (especially Chapters 4 and 9).  But as these inadequacies have been known for a long time, he remarks that we should be “less forgiving” of the failures of those advisers who insisted on shock therapy, with the focus on rapid privatization, in eastern Europe and Russia.  People who “failed to understand modern capitalism” were claiming to be able to teach others how to create it!5

Stiglitz’s larger criticism of the WC, however, is that it fails to see that economic development and transition are essentially about societal transformations, “a movement from traditional relations, traditional ways of thinking, traditional ways of dealing with health and education, traditional methods of production, to more ‘modern’ ways” (p. 58).  And, as such, development cannot be left to economists:  “the hardest questions concerning the reform process take us beyond economics, beyond politics, to issues concerning evolution and change in society - issues which were given short shrift in the early debate, and about which we have insufficient evidence to make statements with the confidence we would like” (p. 159).

Societal transformation

This broader view of development, as a transformation of society, leads to a number of other key elements in Stiglitz’s approach to development and transition issues.  One is to recognize the limits of expertise:  expertise is important, but economists who ignore wider political and social issues are unlikely to succeed and, by the same token, it needs to be recognized that economic objectives cannot be achieved with economic instruments alone.  It must also be acknowledged that expertise is not ‘value-free’:  experts have their own special interests (tenured academics may have a stronger aversion to a rise in the inflation rate than an increase in unemployment), and economic and other policies often involve choices which cannot be made on purely technical grounds.  (Stiglitz makes some sharp points here about the limitations of central bankers and the alleged benefits of independent central banks.)  There is also a strong tendency for experts to see themselves as custodians of ‘universal’ (general and codified) knowledge and to downplay the importance of local and tacit knowledge.  This encourages a neo-colonial mentality where advice and recommendations are dispensed from the top and the need for local adaptation and initiative is neglected, thereby increasing the risks of failure.

From this point Stiglitz enlarges on the themes of encouraging “active social learning”, “ownership” of development strategies, “participation” and “partnership”, and so on.  For anyone who is getting tired of hearing mediocre bureaucrats and activists chanting these terms ad infinitum and is wondering whether there is any substance behind the buzz, this is the book to read.  Stiglitz not only provides the substance but he also integrates it with an articulate understanding of the democratic process, which is not only intrinsically important but also a necessary condition for bringing about and sustaining the societal transformation needed for development.  Like Myrdal, he understands the necessity of taking explicit account of the interdependence of economic, social and political structures.  And, also like Myrdal, he believes in stating his own value judgements clearly:  thus, “I am not convinced that there is any real trade-off between the pursuit of democratic transparency on the one hand and the stability and growth of the economy on the other.  But in the event there is a conflict, I put my voice solidly behind the importance of democratic processes of openness” (p. 267).

Stiglitz’s stress on the democratic process - and he stresses that democracy is as much about process as voting - leads to his assertion of the crucial importance of openness in government, of the basic right to know what government is doing and why, and to a trenchant attack on government secrecy, which is pervasive even in many democratic countries (his own included).  Meaningful participation requires well-informed participants;  secrecy undermines the democratic process, encourages corruption, and creates mistrust between governments and electorates.  All attributes, it might be recalled, of Myrdal’s “soft state” and major obstacles to development.  Chapter 8 - “On Liberty, the Right to Know and Public Discourse:  The Role of Transparency in Public Life” - is one of the best in the book.  His strong attachment to the virtues of “government by discussion” - for which he refers back to Bentham, Mill and Bagehot but could easily have added, as Emma Rothschild has recently emphasized, Adam Smith, Condorcet and other ‘enlightenment’ thinkers - and his distaste for secrecy anticipate the furore that surrounded him at the Bank:  “Each of us in public life must weigh what we say in public and in private, mindful of the abuses to which excessive secrecy is prone.  In the end, my confidence in the democratic processes leads me to the conviction that there is far more scope for open disclosure, far less risk of ‘undermining’ the authority of institutions, than those who invoke this argument claim” (p. 271).

There is much to react to in this book, as one would expect from a first-class mind grappling with important issues and prepared to change his views in the light of evidence and changing realities.  What is refreshing is his refusal to see economics as a self-contained body of certain knowledge and laws to be dispensed to the rest of society without any regard to their political and social consequences, and, as Chang remarks, his willingness to draw on other disciplines and traditions with “unusual intellectual humility and openness”.  Chang wonders whether Stiglitz, trained in the neoclassical tradition, should still be regarded as a neoclassical economist.  Probably not, although such categorization is unlikely to concern him too much.  My reaction is that in the broad framework in which Stiglitz approaches economic questions, in the importance he attaches to institutional factors, which may often be more important than market relations in determining economic conditions, and in his stress on the role of political, educational and other societal factors on economic development, he is much closer to the tradition of Myrdal and other development economists mentioned earlier.  In fact, Myrdal’s last major work on development (Asian Drama) appeared in 1968 and was quickly overshadowed by the oil shocks of the 1970s, the subsequent debt crisis, and the associated ascendancy of neoliberal economic policies.  This collection of papers and speeches suggests to me that Stiglitz is taking up and reviving the Myrdal tradition.  Young economists who are irritated or bored by the narrow technical focus of so much of modern economics - recalling Max Weber’s remark that the scholar has ceased to be a sage and instead become a technician - should read this book and take themselves off to Columbia where there is at least one sage on campus.

Still business as usual?

Finally it  is worth asking whether Stiglitz’s three-year tenure at the Bank has had any lasting effect in promoting open and informed debate about the activities of the major international financial institutions, which the Financial Times editorialist (quoted above) saw as a desirable legacy of his time in Washington.  Stiglitz occasionally refers to the WC in the past tense (as indeed has Paul Krugman)6, but Chang recalls the case of Professor Kanbur of Cornell, who resigned from the Bank in May 2000 in protest at the censorship of his attempt to place greater emphasis on income redistribution in the World Development Report, to suggest that Stiglitz’s departure was certainly not the end of this particular struggle.  Indeed, the recent case of Argentina suggests that little has changed since the Indonesian and Russian crises, whether with respect to the policies pursued or to the manner in which decisions were taken.7 

The forces working for uniformity, for compelling analysts and others to fall into line and not “rock the boat”, are in fact very strong and, if anything, have probably increased since 1989. Policy remains largely driven by elites, be it the introduction of EMU, shock therapy for Russia, the proposal to reform German grammar, the development of genetically modified foods, etc. etc.;  and these elites get upset when their carefully prepared proposals are rejected or criticized by the people who are supposed to benefit from them but have not been consulted properly in advance.  Policy elites like to think they know best - they do possess expertise but, as Stiglitz notes, they restrict information as much as possible in order to put any opposition at a disadvantage - and when they have polished their proposals, often influenced by special interests or their own values or preferences, they declare “there is no alternative” (a famous British Prime Minister of the 1980s thereby earned the nickname of TINA) and see any open discussion as only leading to obstruction by the ignorant or the reactionary.  These tendencies, supported by the control of important information, most of it, as Stiglitz notes, paid for by the taxpayer, and the tendency to drip-feed some of it to cooperative journalists, help to polarize debate in such a way that critics can be isolated as “not one of us” or “unsound” or as opposing more fundamental principles which are not actually in question.  The whole point of the ubiquitous spin-doctor is to alter the perceptual odds in favour of the  official position  (which will not necessarily be that suggested by the evidence). 

Occasionally the system breaks down, as in 1999 when the Organization for Economic Cooperation and Development (OECD) accidentally published research that cast doubt on the prevailing dogma that employment protection schemes create unemployment - the only way out was for the institution to “disown” its own work.

But the pressures for la pensee unique are by no means confined to the public sector.  KPMG released an interesting study in 1999, without the knowledge (it appears) of top management, which concluded that 53% of cross-border mergers actually destroyed shareholder value while another 30% made no difference; senior executives then had it withdrawn because “we didn’t want people to read into it a negative spin” (Financial Times, 29 November 1999).  There are frequent complaints that economists in major investment banks are increasingly muzzled and cannot be relied upon to provide disinterested analysis to investors (Institutional Investor, June 1999).

The result of such manipulation is a breakdown of trust between governments and electorates and between the business sector and consumers which, as Stiglitz argues, can lead to a corrosive cynicism on the part of the governed that will make it more and more difficult to implement desirable policies and, eventually, undermine the democratic process itself.  A Mori opinion poll in the UK in September 2001 showed that only 1 in 8  of British citizens believed the official view that globalization enhanced everyone’s quality of life.

The same issues arise with international institutions.  One of the problems with the IMF is the perception that it is subject to disproportionate influence by the US Treasury in its decision-making process.  But all international institutions lose credibility and confidence when their secretariats are suspected of being subject to backstairs pressure by individual member governments or by outside corporations.  Stiglitz provides a cogent analysis of why openness and transparency are important and he makes a number of useful suggestions to improve matters.  However, it is far from clear that most governments and officials are prepared to adopt them - for the very reasons that Stiglitz sets out so clearly in this book.     

Paul Rayment retired last year as Chief Economist of the United Nations Economic Commission for Europe, where he was the Director of the Economic Analysis Division and led the team that authored the ECE’s main annual publication, Economic Survey of Europe. An abridged version of the above was published in the South-North Development Monitor (SUNS), No. 5057.

Endnotes

1.   See, for example, Chakravarthi Raghavan, “What Washington Consensus? I never signed any - Camdessus”, South-North Development Monitor (SUNS), #4606, 15 February 2000.

2.   See, for example, Pierre-Richard Agénor et al. (eds.), The Asian Financial Crisis.  Causes, Contagion and Consequences, Cambridge University Press, 1999.

3.   Stiglitz quotes Martin Feldstein’s observation that the Fund’s intrusion into matters not directly related to the crisis was an interference with democratic processes that could be counterproductive for reform.  Martin Feldstein, “Refocusing the IMF”, Foreign Affairs, 77(2), March-April 1998.

4.   Irma Adelman once remarked that had the WC been imposed in “the East Asian miracle countries during the fifties, sixties and early seventies, there would not have been an East Asian miracle”.  Her view was that the WC might be appropriate once a certain level of development has been reached where “growth and savings habits are firmly entrenched in the entrepreneurial and household sectors”.

5.   In a paper published in the latest issue of the United Nations Economic Commission for Europe’s Economic Survey of Europe (2001, No. 2), William Lazonick of INSEAD argues that the mainstream, general equilibrium model of the market economy is fundamentally flawed because it fails to account for the innovative enterprise and therefore is unable to provide an explanation of the process of economic development.  One of his key points is that efficient product and factor markets are more the outcome of successful development than a precondition for it.  Like Lazonick, Stiglitz also draws on ideas from Schumpeter and other heterodox traditions in his analysis.

6.   Paul Krugman, “Dutch tulips and emerging markets”, Foreign Affairs, 74(4), 1995.

7.   Charles Gore also believes it is too early to announce the collapse of the WC.  See his “The Rise and Fall of the Washington Consensus as a Paradigm for Developing Countries”, World Development, 28(5), 200

TWE No. 274 (1-15 Feb 2002) 

 

 


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