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The Washington Consensus and Georgia

Economics Nobel Prize winner Joseph Stiglitz, well-known for sharply criticizing the conventional wisdoms of development economics, once summed up his views in a rhetorical question: “We have felt the pain, when do we get the gain?”

Stiglitz wanted to point out that standard development strategies require countries to pay a high price in exchange for the promise of a better future. The price comes in form of harsh poverty for some members of the society, income reduction for many, social strain, and increased inequality. While it is obvious that the “pains” connected to these standard recipes have struck many countries hard, it is less clear whether the promises of prosperity and growth have realized.


A CONTROVERSIAL STRATEGY

The classical approach to developing a country is the so-called Washington Consensus (WC), deriving its name from the fact that it is traditionally favored by the World bank and the International Monetary Fund, both based in Washington D.C.

The main postulates of the WC are trade liberalization, budget consolidation, macroeconomic stabilization, market deregulation, and privatization of government-run economic activities. These recipes were originally developed for Latin American countries in the aftermath of their financial and economic crises of the 1980s.

In Latin America the outcomes of WC policies were rather disappointing. For example, at the end of the 20th century, some Latin American countries were struck by financial crises (like the 1994 “Tequila Crisis” in Mexico), and liberalization of financial markets, a main postulate of WC, may have been an aggravating factor. Joseph Stiglitz in his 2005 article “The Post Washington Consensus Consensus” (Initiative for Policy Dialogue Working Paper, Columbia University) claims that the growth of this region was “just half of what it was in the 60s and 70s, the decades marked by the ‘failed’ policies of import substitution.” He blames the Washington consensus to cut down the role of the public sector and he emphasizes the fact that some countries were quite successful with policies contradicting the WC. For example, the so-called Asian Tigers (Hong Kong, South Korea, Taiwan, and Singapore) performed impressively with a policy focused on export subsidies.

When the Iron Curtain came down around 1990, many Central and Eastern Europe countries implemented the new and fashionable WC for facilitating the transitions of their socialist economies to market economies. Yet the WC was not designed for transition economies. None of the dysfunctional market economies of Latin America had the typical problems of the late socialist economies, namely inefficiently operating industries and the absence of private ownership of capital.

Moreover, policy makers of Eastern European countries adopted a simplified, superficial version of the WC focusing on precipitous liberalization and privatization. This was based on a naïve belief in the self-regulatory power of free markets that prevailed in the early 1990s, not taking into account that people who had been living in planned economies for 70 years were not instantaneously ready for the life in unrestrained capitalism. Succeeding in a market economy requires skills that were largely unlearnt during socialism, and as a result, much of the wealth of those societies was pocketed by a small group of people (the “oligarchs”) who exploited the ignorance of their compatriots and became incredibly rich.

Stiglitz, who got the Nobel Prize for his work on informational economics, provides a theoretical explanation for these events. It is a well known result in microeconomics that informational asymmetries can prevent markets from achieving desirable outcomes. According to Stiglitz, free markets in Eastern European countries suffered from those very efficiency problems predicted by economic theory when there are information asymmetries among the market participants. Under such conditions, he writes, “there is no theoretical underpinning to believe that in early stages of development, markets by themselves will lead to efficient outcomes” (Stiglitz 2005, see reference above).

After the failure of the WC was widely recognized, Stiglitz and other prominent economists proposed an alternative agenda termed Post Washington Consensus Consensus (PWC). An important component of PWC is its emphasis on the role of the government in providing education and infrastructure, reducing poverty, and regulating the financial sector.


GEORGIA’S EXPERIENCE

Despite its controversial status, WC was a blueprint for the economic policy agenda of Georgia. This is most visibly reflected in the goals of trade liberalization, fiscal consolidation, and price stabilization, outlined in the WC and actively pursued by Georgian governments since 2003.

Whether or not this strategy was and is successful is still to be decided. While Georgia could until recently boast with impressive growth rates, the country suffers from sharp income inequality and considerable poverty in some segments of the society.

Moreover, it is not clear whether the successes of the last years can be attributed to the WC recipes. Given the disastrous economic policies of the Shevardnadze era, almost every somewhat reasonable strategy would have led to improvements. In a situation in which economic activity has more or less come to an end, a lot of growth can be generated just by returning to “normal circumstances”, characterized by a functioning government, bearable corruption levels etc.

One can also argue that trade liberalization, included in the WC core agenda, yielded rather ambiguous consequences for Georgia. It resulted in huge imports that were not covered by corresponding exports, leading to persistent current account deficits (rather unusual for a low income country on this stage of development). This is in line with Stieglitz’s claim that “unless the economy is competitive, the benefits of free trade and privatization will be dissipated in rent seeking, not directed toward wealth creation. And if public investments in human capital and technology transfers is insufficient, the market will not fill in the gap.” (Cited from “More instruments and Broader Goals: Moving toward the Post-Washington Consensus”, Chapter 1 in Ha-Joon Chang (ed.): The Rebel Within, London 2001, pp. 17-56).

One of the main deficiencies of the WC is its disregard of path dependence, i.e. the negligence of the role of a country’s economic history in the outcome of different policies. Trade liberalization may be beneficial for a country that, unlike Georgia, enters the stage with comparative advantages in various fields, while it may be detrimental otherwise.

The deficiencies of the WC agenda urge us to think about more elaborated strategies of development that are adjusted to Georgia’s history and its socio-economic conditions.

The debate continues…

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Guest - Eric on Friday, 24 January 2014 18:42

"Trade liberalization may be beneficial for a country that, unlike Georgia, enters the stage with comparative advantages in various fields, while it may be detrimental otherwise."

Hmm...

Any country has "comparative advantages" in something or other. The problem for Georgia is that it has comparative advantages in re-exporting second hand cars to Armenia and Azerbaijan, oil and gas pipelines, hazelnuts, wine, khinkali &khachapuri, singing &dancing, and of course toast making. None of these comparative advantages are likely to make Georgia a dynamically developing modern economy. Thus, the challenge for Georgia is to "discover" or "engineer" new comparative advantages that can put its talented population into gainful and productive employment.

Washington Consensus policies - by themselves - will not do the trick. All they do is create the basic conditions for economic agents to be able and willing to put their energy in productive activities (as opposed to crime, rent-seeking and redistribution). Economists (and policymakers) would of course differ on the question of whether or not a country should protect infant industries and promote exports. However, there is little debate as to the relative merits of other WC postulates such as getting rid of corrupt regulations (that produce no value for the society), imposing fiscal discipline on the government, ensuring price stability, and for the most part relying on private enterprise for investment, innovation, and job creation.

"Trade liberalization may be beneficial for a country that, unlike Georgia, enters the stage with comparative advantages in various fields, while it may be detrimental otherwise." Hmm... Any country has "comparative advantages" in something or other. The problem for Georgia is that it has comparative advantages in re-exporting second hand cars to Armenia and Azerbaijan, oil and gas pipelines, hazelnuts, wine, khinkali &khachapuri, singing &dancing, and of course toast making. None of these comparative advantages are likely to make Georgia a dynamically developing modern economy. Thus, the challenge for Georgia is to "discover" or "engineer" new comparative advantages that can put its talented population into gainful and productive employment. Washington Consensus policies - by themselves - will not do the trick. All they do is create the basic conditions for economic agents to be able and willing to put their energy in productive activities (as opposed to crime, rent-seeking and redistribution). Economists (and policymakers) would of course differ on the question of whether or not a country should protect infant industries and promote exports. However, there is little debate as to the relative merits of other WC postulates such as getting rid of corrupt regulations (that produce no value for the society), imposing fiscal discipline on the government, ensuring price stability, and for the most part relying on private enterprise for investment, innovation, and job creation.
Guest - Florian Biermann on Friday, 24 January 2014 20:51

True, according to the Ricardo Model, every country has a comparative advantage in something. The way you put it, i.e. Georgia having less profitable comparative advantages, is probably what the author wanted to say :).
Btw: The idea that comparative advantages are not all equally profitable was picked up by Paul Samuelson in one of his last papers, when he was already over 90 years old. In that paper, he finally turns away from the Ricardo Model which he defended all of his life...

True, according to the Ricardo Model, every country has a comparative advantage in something. The way you put it, i.e. Georgia having less profitable comparative advantages, is probably what the author wanted to say :). Btw: The idea that comparative advantages are not all equally profitable was picked up by Paul Samuelson in one of his last papers, when he was already over 90 years old. In that paper, he finally turns away from the Ricardo Model which he defended all of his life...
Guest - RT on Friday, 24 January 2014 21:42

An interesting article. Have to re-read and digest.

But why are persistent current account deficits "rather unusual" for a low income country? In a low income country, savings are low and investment needs are high. So either the country undertakes investment with external financing, i.e. runs a current account deficit, or it does not undertake investment and remains a low-income one.

P.S. from here you can see the current account for developing and emerging countries. http://www.imf.org/external/pubs/ft/weo/2013/02/weodata/weoselgr.aspx

There are plenty of deficits. Of course, not each of them is a "good" deficit as I described, some of them are "bad", in the sense of external money financing consumption and not helping with investment

An interesting article. Have to re-read and digest. But why are persistent current account deficits "rather unusual" for a low income country? In a low income country, savings are low and investment needs are high. So either the country undertakes investment with external financing, i.e. runs a current account deficit, or it does not undertake investment and remains a low-income one. P.S. from here you can see the current account for developing and emerging countries. http://www.imf.org/external/pubs/ft/weo/2013/02/weodata/weoselgr.aspx There are plenty of deficits. Of course, not each of them is a "good" deficit as I described, some of them are "bad", in the sense of external money financing consumption and not helping with investment
Guest - Zviad Zedginidze on Tuesday, 28 January 2014 01:13

Really an interesting view from the perspective of an idealist, believer of the government’s important role in developing economy beyond enabling markets to function well : )

I admit that context specific reforms targeted to constraints that economy faces can stimulate economic development as we read from the empirical evidence of some Asian countries…. I also believe that first generation (WC) reforms have delivered really high pay-offs for Georgia, while leaves a lot of room for creative strategies to overcome binding constraints on growth.

Really an interesting view from the perspective of an idealist, believer of the government’s important role in developing economy beyond enabling markets to function well : ) I admit that context specific reforms targeted to constraints that economy faces can stimulate economic development as we read from the empirical evidence of some Asian countries…. I also believe that first generation (WC) reforms have delivered really high pay-offs for Georgia, while leaves a lot of room for creative strategies to overcome binding constraints on growth.
Guest - Florian Biermann on Thursday, 30 January 2014 22:33

Interesting link you provide. I was not aware of that. What the author probably had in mind are some East Asian economies that developed through very clear-cut export strategies.

Interesting link you provide. I was not aware of that. What the author probably had in mind are some East Asian economies that developed through very clear-cut export strategies.
Guest - Tamuna on Saturday, 27 September 2014 01:54

Discussions about economic growth and poverty issues started in 50s with hypothesis of Kuznets and Solow. Both have a hope that poor countries will cope with economic problems. Twenty years observation completed with disappointment and poverty received rather extreme form in some areas of the world. Mid 1970s - the late period of Washington Consensus policies, characterized with debates within orthodox economical school, between state domination and free market supporters. This period changed with Post Washington in 90s and at the begging of 2000s mutated in pro-poor, and more recently in inclusive growth epoch (Saad-Filho 2010).

Discussions about economic growth and poverty issues started in 50s with hypothesis of Kuznets and Solow. Both have a hope that poor countries will cope with economic problems. Twenty years observation completed with disappointment and poverty received rather extreme form in some areas of the world. Mid 1970s - the late period of Washington Consensus policies, characterized with debates within orthodox economical school, between state domination and free market supporters. This period changed with Post Washington in 90s and at the begging of 2000s mutated in pro-poor, and more recently in inclusive growth epoch (Saad-Filho 2010).
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