The Washington Consensus refers to a set of free-market economic policies supported by prominent financial institutions such as the International Monetary Fund, the World Bank, and the U.S. Treasury. A British economist named John Williamson coined the term Washington Consensus in 1989.
The ideas were intended to help developing countries that faced economic crises. In summary, The Washington Consensus recommended structural reforms that increased the role of market forces in exchange for immediate financial help. Some examples include free-floating exchange rates and free trade.
Critics have pointed out that the policies were unhelpful and imposed harsh conditions on the developing countries, others have defended the long-term positive impact of these ideas.
The Original Principles of The Washington Consensus
These are the ten specific principles originally set out by John Williamson in 1989:
- Low government borrowing. The idea was to discourage developing economies from having high fiscal deficits relative to their GDP.
- Diversion of public spending from subsidies to important long-term growth supporting sectors like primary education, primary healthcare, and infrastructure.
- Implementing tax reform policies to broaden the tax base and adopt moderate marginal tax rates.
- Selecting interest rates that are determined by the market. These interest rates should be positive after taking inflation into account (real interest rate).
- Encouraging competitive exchange rates through freely-floating currency exchange.
- Adoption of free trade policies. This would result in the liberalization of imports, removing trade barriers such as tariffs and quotas.
- Relaxing rules on foreign direct investment.
- The privatization of state enterprises. Typically, in developing countries, these industries include railway, oil, and gas.
- The eradication of regulations and policies that restrict competition or add unnecessary barriers to entry.
- Development of property rights.
Criticisms of The Washington Consensus
- Some economists argue that free trade is not always in the best interest of developing economies. Some strategic and infant industries have to be protected initially to provide long-term growth. These industries may also require protection in the form of subsidies or tariffs against imports.
- Chinese firms, aided by the government, have been investing large sums in developing economies in Africa, Asia, and Latin America. These firms typically invest in infrastructure, creating opportunities for long-term trade and growth.
- Privatization can increase productivity and enhance the quality of the product or service. However, privatization can often lead to companies ignoring certain low-income markets or the social needs of a developing economy.
- The free market has its own faults and instabilities. As we saw with the Great Recession in 2008-2009, increased deregulation can lead to financial volatility that can infect the entire economy.