Washington Consensus – a blessing or a curse?

Poland is considered an example of a country that has undergone a successful transformation from a socialist to a market economy. The country's economic growth is unprecedented in its history, but now voices about the huge social costs of the above-mentioned reforms are increasingly being heard. For many people, the "Balcerowicz Plan" was introduced too quickly and without any "shock absorbers". However, it is worth remembering that the climate at the turn of the 80s and 90s was completely different than now. The so-called Washington Consensus, which was a package of directives that were intended to help the country quickly become marketized, triumphed.

In theory, this was supposed to lead to faster modernization of the country and significant improvement in the wealth of society. That's why "Balcerowicz's plan” had so many neoliberal solutions “sewn into it.” The faces of neoliberalism at that time were Ronald Regan and Margaret Thatcher. Unfortunately, not all countries have benefited from this policy, but some are grateful for the thoughtless implementation of neoliberal solutions. One of them is undoubtedly Hugo Chavez... In today's text I will briefly explain what the Washington Consensus is.

What is the Washington Consensus and who was it created for?

The Washington Consensus is a set of ten economic policy directives that was created in the 80s. Its assumptions promote a neoliberal model of economic development. The American government recognized the Washington Consensus as a recommended reform package to improve the economic situation in developing countries that are in crisis. Its assumptions include limiting the role of the state in the economy, promoting free market policy, trade liberalization, privatization and liberalization of finance, property protection and privatization of state-owned enterprises. In the assumptions of the Consensus fiscal and monetary policy played an important role, which was aimed at minimizing budget deficits and inflation. The Washington Consensus was promoted by institutions such as the World Bank, the International Monetary Fund and the United States Department of the Treasury.

This name was first proposed in 1989 by the liberal British economist, James Williamson. The Consensus was created with Latin American countries in mind. The countries of this region were immersed in a debt crisis in the 80s. The crisis was caused by the governments of those countries "flirting" with socialism. Exaggerated social spending combined with the nationalization of many branches of the economy. This resulted in large inefficiencies, which over time led to the crisis and the "lost decade". The original consensus was intended to help achieve economic transformation and raise living standards.

Thanks to global efforts, Consensus directives have become part of the canon of world economic policy. To this day, the assumptions are propagated by International Monetary Fund and the World Bank. The Stability and Growth Pact of 1997 concluded between the European Union countries, although often violated, was based on the principles developed by Williamson.

The original assumptions of the Washington Consensus

The Washington Consensus assumes limiting state intervention in the economy and opening up to economic contacts with other countries. The Washington Consensus strongly emphasized the need to liberalize trade and capital flows, as well as privatization. In its assumptions, monetary discipline and reform are very important simplifications in the tax system and facilitating the establishment and liquidation of enterprises. In its original form, the Consensus contained 10 broad sets of policy recommendations, which include:

1. Maintaining fiscal policy discipline. Action within this principle was based on maintaining a low budget deficit. This was intended to improve the country's perception on the international arena. The smaller deficit was supposed to help lower interest costs.
2. Prioritizing public spending. Public financial resources should be redirected to pro-development purposes. These include expenditure on the development of infrastructure, education and health care. Infrastructure in particular is key to supporting long-term economic growth and reducing disparities between regions.
3. Tax reforms aimed at reducing marginal tax rates and expanding the tax base. The aim of this assumption was tax reform aimed at reducing tax rates, especially on income taxes related to goods and services. Lower taxes were intended to reduce the gray zone and encourage economic activity.
4. Interest rates – the task of the central bank was to control inflation and maintain positive, real interest rates. Of course, it was important that the central bank did not keep interest rates artificially high.
5. Exchange rates. A single exchange rate should be maintained and kept at a sufficiently competitive level to stimulate exports. A fixed exchange rate was a restrictive idea to force governments and central banks to act cautiously.
6. Trade liberalization. The main assumption of this directive was the abolition of various restrictions, especially quantitative ones, but also trade protection, which was manifested in the process of reducing customs duties and adapting a single customs tariff at an average level of 10%. Thanks to this, markets were opened to foreign products and services, which was supposed to modernize the industry as a result of greater competition.
7. Liberalization of foreign direct investment flows. The aim of this assumption was to eliminate entry barriers for foreign companies to the market and treat them as state-owned enterprises. Thanks to this, investments were to flow to such a country. At the same time, the stable exchange rate meant that foreign investors did not have to worry about exchange rate risk.
8. Privatization of state-owned enterprises. In order to improve the efficiency of the private sector, the state sector had to be privatized. For privatization to be successful, foreign investors had to be included. Theoretically, privatization was supposed to improve the quality of management, which was supposed to contribute to improving the profitability of invested capital.
9. Deregulation of markets related to the rules of entering the market and supporting competition. The state should abolish regulations that hinder market entry or restrict competition. Only companies related to national security, environmental protection and prudential supervision of financial institutions should be exempt from this rule. Companies should be unlimited and operate in accordance with the rules prevailing on the market. This action was intended to facilitate the creation of new companies with domestic and foreign capital.
10. Protection of property rights. The state should have guarantees related to its property and have security in the event of nationalization. This was intended to encourage foreign capital to make larger investments.

Reading the directives, you can see that they were very beneficial to large foreign corporations that had large amounts of money. Thanks to deregulation, such companies were able to quickly gain market shares in economies opening up to the world. As history has shown, in many cases this was the case.

Supplements to the Washington Consensus

In the years following the first version of the Consensus, a decision was made to extend or change the recommendations. This resulted from the first experiences after the introduction of the Washington Consensus. The big disadvantage was that it was not flexible. Therefore, similar solutions were recommended for small economies and countries with tens of millions of citizens. The corrections introduced include:

• Increasing budget discipline – monitoring expenses and collecting taxes,
• Reorientation of public spending – the country should carefully analyze what the goals of social policy are and cut social spending that is not consistent with the goals,
• More comprehensive tax reforms – avoiding tax loopholes that would disturb the balance in the economy,
• Introduction of modern banking supervision – this is to stabilize the banking sector, which minimizes the risk of a banking crisis,
• More flexible exchange rate – light devaluations or revaluations allowed to avoid currency crises,
• Comprehensive solutions supporting the competitiveness of the economy – fair privatization or deregulation of the economy and making the labor market more flexible,
• An independent central bank – monetary policy should be independent of the current political game in the country,
• Supporting interregional trade liberalization – joining transnational free trade zones.

Examples of the Washington Consensus

These principles were also applied to countries that were forced to undergo political transformation. Poland was also among them, and during its economic transformation, it used the recommendations of the Consensus to create the "Balcerowicz Plan". In the case of Poland the most important thing was macroeconomic stabilization and transformation of the economy, but the plan was implemented quickly and violently. As a result of these actions, it was lowered inflation and budget deficit, however, this resulted in an increase in unemployment and a deterioration of the financial situation of individual parts of society.

Latin American countries

As we mentioned earlier in the article, we mentioned that the Washington Consensus was introduced in response to the so-called La Decada Pedida, or "the lost decade". Latin American countries were struggling with a major debt crisis. Backed against the wall they had to agree to implement neoliberal reforms. Regulations in the economy were reduced, which also affected trade unions. Additionally, extensive privatization was introduced. However, in the case of Latin American countries, neoliberalism was also associated with corruption scandals. This discouraged citizens from continuing reforms. In some countries, ineptly introduced liberalization led to an increase in leftist sentiments. A great example is Venezuela, which was the "sick man of Latin America" ​​in the 80s.

Venezuela – a prelude to Hugo Chavez

Venezuela in the 60s and 70s was the “Saudi Arabia” of South America. Huge profits from oil caused the country to modernize quickly. Large infrastructure investments were made and social projects began to be developed. This was supposed to lead to leveling the differences in economic development between regions. However, in the case of social policy, the projects did not bring great results. However, thanks to the high price of oil, structural problems were masked. However, the sharp decline in oil prices in the 80s led to a debt crisis and deteriorated economic prospects. The real shock was the so-called Black Friday of 1983. There was a devaluation of the Venezuelan bolivar. Ultimately, the government of Luis Herrera had to declare its foreign debt insolvent.

The devaluation caused the purchasing power of Venezuelans to decline by 75%. The country has been struggling with a difficult economic situation for many years. Reluctance towards the current economic policy was growing, and neoliberal views were becoming more and more popular on the political scene. In 1988, Carlos Andreas Perez, who was initially against the IMF's policy, came to power. During the election campaign, he spoke harshly about institutions such as the International Monetary Fund and the World Bank. However, the economic situation was so difficult that the Venezuelan government ultimately decided to adopt a package of reforms based on the Washington Consensus.

Ultimately, El Gran Viraje (i.e. The Great Turnaround) resulted in the cutting of fuel subsidies and the deregulation of the economy. The public did not like the reform packagesthat were most affected by the initial reforms. As a result, the famous Caracazo took place, i.e. huge social protests, which were bloodily suppressed. 277 people died in the riots. Unofficial estimates say up to several thousand people died. This did not stop Venezuela's further reforms.

Attempted coup

The next step was the privatization of key enterprises. By the end of 1991, the Venezuelan government had sold shares in three banks, a shipyard, an airline, a sugar factory, and a telecommunications company. During privatization, there were repeated claims that companies were sold significantly below their intrinsic value. Some journalists claimed that politicians from the ruling party responsible for privatization took very large bribes. The good economic situation resulted in... economic growth in the early 90s was 9%, which was the highest result among Latin American countries. The reforms were interrupted by a coup attempt in 1992 by the Bolivarian Movement led by Hugo Chavez. Even though the coup failed, it was a springboard for Chavez's popularity in Venezuelan society.

The years 1993 - 1994 saw further political instability. The situation changed only after Rafael Caldera won the elections in 1994. The problem was astronomical corruption, which caused increasing social stratification and the aversion of the poorer part of society towards the current government. The unstable situation of Venezuelan banks did not improve the situation either. In 1994-1995 there were many banks on the verge of bankruptcy and was nationalized by the government. Advisors encouraged Caldera to pursue further economic reforms. In 1996, another plan called Agenda Venezuela was introduced. It assumed liberalization of the method of setting interest rates on the market and the creation of a partially floating currency regime. Price controls (except for medicines) were also abolished and capital flow controls were reduced. This resulted in a rapid inflow of foreign investments. As a result, in 1997 GDP increased by 5%. Unfortunately, in the same year, a problem occurred in Asia that caused oil prices to fall. The decline in budget revenues resulted in an automatic reduction in expenses. As a result, spending (including social spending) began to be reduced.

During Caldera's rule, attempts were made to fight corruption, but it was not successful on a large scale. The resistance of officials and politicians to transparency meant that scandals broke out from time to time. Ultimately, Venezuelan society grew tired of the liberalization of the economy. All that remained of the grandiose announcements about increased prosperity was disappointment. It is no wonder that in 1998 Hugo Chavez won the elections, who talked about abandoning the Washington Consensus, nationalizing some sectors of the economy and increasing social transfers. Ultimately, after years of experiments with Chavismo, Venezuela is in an even worse situation than in 1998.

Discussion about the Washington Consensus

The topic of the Washington Consensus has been controversial for years. Some critics have doubts about the original assumptions related to the opening of developing countries to the global market. Without a transition period, regional companies were literally "eaten" by better-managed and wealthier foreign companies. Deregulation of the labor market resulted in the position of employees being weaker than before the liberal reforms. Neoliberal laws benefited either enterprising people or those closely associated with the government. The latter examples in particular caused frustration among the poorer part of society. There was also a phenomenon privatizing profits and nationalizing losses. This was the case in Venezuela when the government had to nationalize some banks. This did not prevent the managers of these banks from receiving high salaries.

Other participants in the Consensus discussion claim that the problem lies in the areas that are missing in the first set of recommendations. This includes: institutional development and equalization of opportunities among citizens. The aspect of improving the living conditions of the poorest was also neglected, because there was an opinion that "a rising tide will lift all boats." Unfortunately, it turned out that some of the boats had holes in them.

The biggest problem with the Consensus is its strict applicability to different situations in different economies. Identical restrictions on the deficit, public debt, low taxes and privatization of state-owned enterprises. Another problem was often the imposition of these assumptions on countries that were not prepared to implement them quickly. Methods used include removing trade barriers, deregulating markets and privatization therefore, they did not bring the expected results. Moreover, the restrictive requirement to maintain fiscal discipline contributed to the suppression of economic growth.

However, the real problem was often within the political class. After all, liberal reforms in Poland have generally turned out to be successful. However, in Latin America they ended in a "small disaster". A particularly big problem was corruption, which flourished during privatization. Poland was also not free from this phenomenon, especially in the 90s. The history of the Washington Consensus shows that There are no silver bullets when it comes to sustainable development. People who currently believe that the "Chinese model" can be easily applied to other countries should also remember this.