History of Washington Consensus - Term Paper Example

History of Washington Consensus The Washington Consensus was designed to take the developing countries out of their debt crisis. The consensus was made keeping in mind the fact that by helping the debtor countries out of the debt burden, the economy will eventually gain. The Washington Consensus was initially designed by John Williamson. The Consensus consisted of a set of ten economic policies as listed below. 1. It recommended the introduction of a fiscal discipline among all the debt wrecked countries. The economy of the developing countries suffered largely because of the huge debts. This created huge deficits in the BOP of such countries, ultimately leading to inflation. Hence, it is extremely necessary to establish a fiscal discipline. 2. The consensus recommended in shifting the public expenditure from non-merit subsidies to the development of infrastructure of the basic requirements like health and education. The expenditure cuts that were recommended were meant to give the public sector an affordable size in these economies. 3. There was a recommendation for the revision of the tax-system. It aimed at making a tax system that will be a combination of moderate marginal tax rates and broad tax base. 4. It prescribed the liberalisation of interest rates. Liberalisation of interest rates will be done by allowing the interest rate to be determined by the market forces. 5. It recommended the use of a competitive exchange rate. A sufficiently competitive level of exchange rate is expected to encourage rapid growth in the nontraditional exports. 6. The most important recommendation was trade liberalisation. The consensus expected that trade liberalisation can be brought about by replacing the quantity barriers with lofty tariffs. The high tariffs will be collected as rent and will directly help the government. Secondly, this replacement will allow enhancement in the import quantities. 7. Entry barriers for the foreign investors should be encouraged. This will give way to the FDI in the economy of the developing countries. It is believed that flow of FDI is more reliable and stable than the bank loans and portfolio capital. Hence, investment incentive though foreign direct investment should prove economically healthy for the Asian crisis. 8. The consensus suggested privatisation of the state owned enterprises. The private enterprises are more proficient and effective in terms of service and regulation compared to state enterprises. 9. It suggested the abolition of regulations that hampers the entry of new firms in the market and competition. Only those regulations should be allowed to stay which restricts competition in the market for the sake of environment, consumer protection and safety. 10. The tenth recommendation was the establishment of a legal system that will provide sufficient security to the property rights without involving excessive costs ( Williamson J., January 2004). Idea behind Washington Consensus: Neo-liberalism The economic idea that shaped “Washington Consensus” is neo-liberalism. Liberalism had once been a popular political ideology. With the passage of time it lost its significance and it was revived recently in a new form termed as “Neo-Liberalism”. Neo-liberalism is an economic and political philosophy that moves in the paths of market expansion, free trade and privatisation. The idea of neo-liberalism is guided by a set of principles. The theory relies on the market mechanism for regulating the economy, thus it allows trade openness both locally and globally. The theory describes any restriction on the market rules as means of reducing efficiency. In 1994, North American Free Trade Agreement (NAFTA) was created on the basis of the neo-liberal theory. The NAFTA aimed at eliminating the trade barriers among Mexico, United States and Canada in order to maximise profit. NAFTA also encouraged the privatisation of the government enterprises. The prime idea that backed the privatisation of the state owned enterprises was the introduction of foreign capital within the nation to stabilise the economy. The idea of neo-liberalism achieved its significance during 1980s. During the 1980s the third world countries, especially Latin America and Sub-Saharan Africa, showed poor economic growth. These countries faced the problems of falling prices, high debt burden, high interest rate and decline in investment rate, which deteriorated the economies at a fast pace. During this period, these nations realised that through neo-liberalism they would be able to find a solution to the problems faced by them. The theory intended to stabilise the economies by introducing liberalisation and privatisation in these countries. United States used the economic theory of Neo-liberalism to keep the third world countries away from socialism and offer a better democracy (Cline C., n.d.). The theory of neo-liberalism drifts away from the idea of liberalism by including the issues of private property rights and rule of law. The proponents of neo-liberalism state that constitutionalising the economic right is extremely essential for the smooth flow of goods and services within an economy and also across the borders. The theory insists on the issues of ensuring economic expansion through market openness and the protection of private property rights (Schneiderman D., 2008). The Washington Consensus as discussed before stands on the fundamentals of neo-liberalism. The objective of the consensus was to induce the practices that are prudent for the macroeconomic framework of a country. Thus, the governments of both the poor and rich countries maintained “macroeconomic prudence”, privatisation, deregulation and economic liberalisation. Recently, the Washington Consensus has been transformed into “Augmented Washington Consensus” (AWC). AWC has been supplemented with the concern of poverty eradication and a wide range of other governance issues. The AWC insists on good governance through the promotion of civil society, commitment to poverty reduction, capacity and institution building. It is evident from the stress on the encouragement of civil society and poverty reduction in the new version of Washington Consensus, that it differentiates itself from the original spirit of neo-liberalism. The AWC supports the idea of foreign direct investment to boost the countries financially, which can later provide resilience during the phase of volatility and shock (Beeson M. and Islam I., n.d.). Economics of Competition The trade liberalisation supports the abolition of all the trade barriers. This abolition is meant to provide competition among the different nations of the world in providing goods and services. It can be inferred from the economic theory of competition that the consumers will eventually be benefited by getting the socially optimal price of the goods and services. It is because of this reason that all the enterprises will compete to offer the cheapest price in order to have a greater market share. Structural Adjustment Program The poor fiscal balances of the developing countries were notable during 1990s. During this period, International Monetary Fund and World Bank implemented the structural adjustment program for the developing countries. The policies aimed at providing low interest rates on the existing loan to the developing nations. Both IMF and WB granted loans that were designed to pay off the debt by the countries. SAP (Structural Adjustment Programs) is a set of economic policies that made a country eligible for the WB and IMF loans. The SAP included the guiding principles of privatisation, liberalisation, export-led growth and efficiency of free trade. World Trade A bird’s eye view on the trade policies of some important nations of the world will give a glimpse of the theory which supports the policies. The economy of USA is the most significant one as it forms the center of the global trade relations. The international trade policies of USA support the free-trade agreements thoroughly. Recently the country has negotiated upon this issue to achieve high conservation standards. The country has laid immense stress on environmental protection. Since the 2002 Trade Act, USA has negotiated about free-trade agreements (FTAs) which require the parties to implement environmental laws and strive sincerely to achieve superior stage of environmental protection. USA has recognised the need of free trade for its trading partners. (Anders J., April 2007) According to the North American Free Trade agreement United Kingdom and United States of America have joined hands for bilateral free trade. This displays the insistence of free trade by UK, which has implemented legislation in support of free trade agreement by the end of 2003. (Gramm P., January 2001) In 2000 UK’s department for trade and industry joined hands with the Federal trade commission to facilitate enforcement of law with regards to consumer protection. With the advent of internet, now consumers are extensively engaged in cross-border transactions. Consequently, this calls for the need of cross-border law enforcement cooperation. (United States And United Kingdom Sign Agreement to Enhance Cooperation on Consumer Protection Matters at First U.S. Meeting of International Marketing Supervision Network , October 2000) Japan, which is an economically robust nation shares strong trade relation with USA. Japan also holds a strong support to free trade agreements since it is contemplating the issue of opening its market and allowing free trade. In near future Japan is expected to pursue reforms that will help to curtail the protection from its markets. (Shark D., February 2009) The World Trade Organization that is responsible for fair global trade considers protectionism to be a threat to economic prosperity. WTO has recognised that free trade can provide a way out of the economic recession. In the latest WTO meet, the prime issue of discussion was protectionism. Governments across the world are now making reforms that can lead to free trade globally. WTO has also made an attempt to monitor the trade barriers being put up by countries around the world. The WTO believes that trade is not the evil but the economic recession is. And to come out of the economic meltdown it is extremely essential to carry on free-trade. Due to economic recession, negative sentiments have been built up in the countries regarding free trade. Every country is taking serious steps to safeguard its industries and jobs which will eventually aggravate the recession. The WTO fears that if such protectionism is not abolished well before time, the world might face the situation of Great Depression again (Seager A., 2009). Benefits of Trade Liberalisation Trade liberalisation is coupled with various benefits and hence organisations like IMF and WTO lay stress on open economy. The developed countries of today could not have achieved the massive economic growth without opening up their economies. The trade liberalisation paired with foreign investment has played a key role in the economic success of the East Asian countries. The developing countries have developed competitive edge by opening up their economies. With the liberalisation of trade the developing countries have the strength to face the tough competition. Consequently, the countries have recognised their potential and have benefited from the comparative advantage. (Global Trade Liberalization and the Developing Countries, November 2001) On the superficial level, free trade may seem to have harmful effects on the developing nations and the under developed nations. But if one delves deep[er into the actual scenario one will realise that free trade is responsible for opening up several new job opportunities in these countries. As a result of which the income of the unskilled people of the country has increased. As a result the incomes of developing countries have increased almost in the same proportion as that of the developed countries. The inequality among the countries has been noted to decline since 1990, following the liberalisation of trade. According to IMF (International Monetary Fund), a complete abolition of trade barriers will increase the merchandise trade from US $250 billion to US $680. Around two third of this increase will benefit the developed countries. The rest one third will be accrued by the developing countries, which will be higher than the financial aid they receive presently. (Global Trade Liberalization and the Developing Countries, November 2001) Conclusions Today the WTO is moving with the objective of free trade. Globalisation and liberalisation that are engulfing the nations gradually will ultimately lead to the same spirit of neo-liberalism. The idea of neo-liberalism has taken several turns from Adam Smith’s invisible hand theory. It has been revised and adapted to provide better outcomes. In the current trend of globalisation, it would not be advisable for any nation to put up trade barriers. This will isolate the country from reaping the benefits of a competitive global market. But along with reaping the benefit from trade liberalisation, a developing country must take into account its potential. It should recognise its potential as well as estimate the investment required to acquire potential in other goods and services. For a developing nation the government intervention in trade is essential to safeguard the country’s interests during the time of global financial shocks. If a developing nation is left without any barriers to trade then even the slightest tremor in the global market can compound to form a greater shock for the nation. It is extremely advisable to keep a perfect balance between the free trade and government regulation. 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