The term "Washington Consensus" was coined in 1989 by economist John Williamson of PIIE. He was describing a list of policies that had gained support among Latin American policymakers in response to the macroeconomic turbulence and debt crisis of the early to mid-1980s. These policies also had the backing of experts at Washington's international institutions—especially the International Monetary Fund and the World Bank, as well as the US Treasury—to help the recovery from the debt crisis.
Though Williamson intended his list to be more descriptive than prescriptive, the term took on a life of its own, starting in the 1990s, when it became synonymous with privatization and easing of state control over national economies after the fall of communism. After decades of turbulence in the global economy and countries' mixed successes at policy reforms, the phrase "Washington Consensus" raises red flags among some economists while providing enduring wisdom among others.
The main Washington Consensus policies include maintaining fiscal discipline, reordering public spending priorities (from subsidies to health and education expenditures), reforming tax policy, allowing the market to determine interest rates, maintaining a competitive exchange rate, liberalizing trade, permitting inward foreign investment, privatizing state enterprises, deregulating barriers to entry and exit, and securing property rights. Williamson noted that these policies contradicted conventional wisdom in developing countries, many of which embraced state dominated systems in the 1950s.
What is the "Washington Consensus"?
1. Reduce national budget deficits
Large budget deficits had contributed to high and variable rates of inflation in Latin America in the 1980s; policymakers prescribed fiscal discipline—by raising tax revenues or cutting domestic spending—to reduce the need for government borrowing and restore economic stability.
2. Redirect spending from politically popular areas toward neglected fields with high economic returns
Some components of public spending—subsidies to state-owned firms, or for food or fuel consumption—led to economic distortions and favored richer urban populations as opposed to the rural poor. Reducing subsidies of politically connected economic sectors can inflict costs on some but frees up spending to support basic social services, education, and infrastructure.
3. Reform the tax system
Reforms should broaden the tax base and remove exemptions that exclude some politically connected taxpayers and organizations from paying taxes. Broadening and simplifying taxes can promote efficiency, improve tax collection, and reduce tax evasion.
4. Liberalize the financial sector with the goal of market-determined interest rates
Government controls on interest rates tend to punish savers and discourage investment while stifling financial development; rationing credit tends to breed corruption and favor political insiders. Market-determined interest rates promote savings and ensure that banks or financial markets, not government politicians, determine allocation of credit.
5. Adopt a competitive single exchange rate
Move away from overvalued exchange rates that discourage exports and lead to foreign exchange rationing; a competitive market-driven exchange rate can promote export-led economic growth and reduce balance of payments problems.
6. Reduce trade restrictions
Trade restrictions that promote special interests should be reduced in general. Tariffs are preferable to quotas and other arbitrary trade restrictions that strangle trade; gradually reduced, they allow domestic firms to adjust and, unlike quota rents for special interests, yield revenue for the government.
7. Abolish barriers to foreign direct investment
Banning or restricting inward foreign investment gives domestic firms a monopoly and reduces competition. Foreign investment allows a country to gain capital, create jobs, and build skills, while exposing domestic firms to greater competition. Domestic companies that tap foreign direct investment (FDI) can foster intellectual property innovations that contribute to development.
8. Privatize state-owned enterprises
State-owned firms are often inefficient, surviving only with the help of government subsidies that widen countries' fiscal deficits. Privatization may cause some unemployment but is more likely to raise the efficiency and profitability of businesses and increase national productivity and growth.
9. Abolish policies that restrict competition
Removing regulations and obstacles that prevent new firms from entering the marketplace can stimulate competition, efficiency, and economic growth.
10. Provide secure, affordable property rights
A legal system that grants and upholds property rights, including the rights of people working informal jobs not officially reported and holding land without official documentation, incentivizes investment and individual liberty. Private assets enable owners to access credit, expanding the economy and the government's tax base.
Source: John Williamson's lecture, "The Washington Consensus as Policy Prescription for Development," delivered at the World Bank on January 13, 2004.
Economists remain divided over the applicability of these "reforms." Some note that their implementation has inflicted economic pain and hardship in poor countries without delivering promised economic growth. Williamson himself came to question some of the consensus precepts but argued that critics had distorted them for political purposes.
Today, however, a growing body of recent research suggests that the prescribed reforms generate tangible benefits to GDP without increasing levels of inequality any higher than in countries that pursued alternate development policies. The debate will no doubt continue, however.
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