Context

Lately economists have cautioned that the Washington Consensus is losing its hold over institutions.

About

• Washington Consensus: The Washington Consensus is a set of 10 economic policy prescriptions by Washington, D.C.-based institutions such as the International Monetary Fund (IMF), World Bank and United States Department of the Treasury.
  • It constitutes the "standard" reform package promoted for crisis-stricken developing countries.
  • The prescriptions encompassed policies in such areas as macroeconomic stabilization, economic opening with respect to both trade and investment, and expansion of market forces within the domestic economy.
• 10 Policy prescriptions:
  • Fiscal policy discipline, with avoidance of large fiscal deficits relative to GDP.
  • Redirection of public spending from subsidies (especially indiscriminate subsidies) toward broad-based provision of key pro-growth, pro-poor services like primary education, primary health care and infrastructure investment.
  • Tax reform, broadening the tax base and adopting moderate marginal tax rates.
  • Interest rates that are market determined and positive (but moderate) in real terms.
  • Competitive exchange rates.
  • Trade liberalization: Liberalization of imports, with particular emphasis on elimination of quantitative restrictions (licensing, etc.); any trade protection to be provided by low and relatively uniform tariffs.
  • Liberalization of inward foreign direct investment.
  • Privatization of state enterprises.
  • Deregulation: Abolition of regulations that impede market entry or restrict competition, except for those justified on safety, environmental and consumer protection grounds, and prudential oversight of financial institutions.
  • Legal security for property rights.

Criticism

• Most criticism for Washington Consensus has been focused on trade liberalization and the elimination of subsidies, especially in the agriculture sector.
• In nations with substantial natural resources, the focus of criticism is on privatization of industries exploiting these resources.

Is the Washington consensus still relevant?

• Changing IMF stance: It has been argued that IMF might be moving away from the Washington Consensus world view of freely floating exchange rates and opposition to capital controls that dominated its thinking for decades.
• China factor: When Renminbi was just included in the basket of currencies that make up the Special Drawing Rights (SDR), economic concerns led to a massive capital flight that saw China’s foreign exchange reserves go down by a trillion.
  • China imposed drastic capital controls to avoid currency crash so soon after its SDR inclusion. And it worked, unlike Washington consensus prescription.
• Rethinking on the ‘capital account fundamentalism’: The term denotes a belief that free flow of capital provides the greatest possible equity and prosperity, and that any interference with the market process decreases social well-being.
  • However, empirical example suggests, it has not been the case.
  • Free capital flow destabilized emerging economies after the crisis of 2009. Easy monetary policies in the developed world encouraged “carry trade"—cross-border investment in search of higher yields. Capital flooded into emerging economies with higher domestic interest rates. But when Federal Reserve Bank (Fed) tapering started, capital flows reversed, leaving emerging economies very unstable.
• A possible repetition of 2009: If the US economy stumbles into a recession, which presently seems like a possibility, Fed would be left with no choice but to further expand its quantitative easing. And this could once again have consequences on emerging economies.
  • A similar distress can be caused by the actions of European Central Bank which is easy on printing currency and buying bonds that carry negative interest rates.