State Controls, Markets and Washington Consensus

States, Markets, and the Good Society

Milton Friedman: there are only two ways to coordinate the economic activities of millions. One is central planning by the government; the other depends on the voluntary cooperation of individualsthe techniques of the marketplace. Key question: what balance between states and markets (political economy) most enhances peoples capability and contributes to the good society?

Market systems

Market system = an economy in which production for profit is intended for and coordinated through private exchanges between buyers and sellers
Productive assets are privately owned and employed to earn profits for their owners Production is geared to produce commodities, goods for sale in the market Prices are set through market forces, supply and demand

Over time, the market system has become more extensive (involving more international transactions) and more intensive (involving more social transactions) States determine how extensive markets are

Taxation on imports Regulations on foreign investment Controls on currency Trade treaties/international organizations

States determine how intensive markets are

Restrictions on what is/can be for sale in the market

States and Markets

Charles Lindblom: Like the statethe market system is a method of controlling and coordinating peoples behavior. Market systems require states and cannot exist without them States make market system possible, making ground rules that permit the system to work
States create common currency, facilitate trade and exchange, enforce contracts, supply public goods (transportation, police, courts, etc.), which markets cannot provide

Visible hand of state supplements invisible hand of market Market freedom requires state compulsion Markets only as good as rules states make to support them Political economy = balance between political and market forces, critical to creating conditions for the good society As with political institutions, it is important to get economic institutions right

Economic Planning

Central Planning Vs Market Economy Central Planning has been criticized a lot due to

inherent weaknesses and inefficiencies in political and

administrative (bureaucratic) structures.

Market inefficiencies compel states to intervene to Planning then and now Indicative/Directional Planning (Process Approach) (National Development and Reform

safeguard the well being of the masses.

China

Commission)
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Advantages of Market Systems

Extraordinarily dynamic

Promote new products, more efficient production methods and technologies Competition and profits encourages innovation

Enormously productive
Leading to rising incomes and living standards

Enhance prospects of democracy and political rights; does not ensure democracy and political freedom
Market systems separate economic from political power (potentially countervailing tendencies)

Dark Side of Market Systems

Highly volatile
As we know all too well at present, susceptible to periods of boom and bust

Volatility can be socially destructive

Unemployment, wasted resources, reduced investment, reduced incentives for re-training
Can lead to sense of powerlessness, insecurity

Generate extraordinary inequality

Depresses earnings of those without valued skills; undermines bargaining power of unskilled workers; market position of low skill workers declines
Expands power of those who control scarce resources (skills, capital); market position of those with market power increases

Create harmful spillover effects (externalized costs)

Markets encourage participants to adopt a narrow perception of interests; encourage participants to avoid the costs of their decisions and to pass them on to others, to the detriment of society; examples: pollution, global warming/climate change

Shifting Balance

Market systems require rules enforced by the state to work

Effective rules reduce uncertainty that contracts will be honored, money will retain value, consumers wont be cheated

States also steer economies toward certain goals States intervene in the market

Counteract disadvantages: welfare systems, pollution controls, even out swings in business cycle, etc.

Degree to which states should intervene in the marketplace a source of conflict in most societies
Boundary between what should be left to market and what should be determined by states shifts in response to political pressure, and has shifted over time in response to changing circumstances Post-WWII, state intervention (mixed economies) considered appropriate in developed and developing countries By 1970s, recession created grounds for new groups (in particular, the business community) to challenge mixed economies; gave rise to market advocates (e.g., Reagan, Thatcher) who criticized the state for spending, taxes, and regulation Whereas advocates of mixed economies pointed to market failures, freemarketeers pointed to political failures
Growth slowed because welfare state undermined work ethic Regulations limited entrepreneurialism Taxes diverted too much income Public enterprises did not perform

Globalization

Globalization = increasing flow of money (investment), people, skills, ideas, and goods (trade) across borders (market extension)
While there has always been trade, investment, and cultural exchange across borders, there is a qualitative difference today in the volume of international exchange, breadth/depth of connections/transformations, and speed In part, result of technological change (transportation, communications) Also promoted by MNCs, governments, international agencies

Washington consensus (neoliberalism)

Balance budgets, cut spending, open markets to foreign trade/investments, privatization of industries Supported by large MNCs, US, and World Bank/IMF
Made economic assistance dependent on adoption of neoliberal policies

Neoliberalism

Prescription (to promote efficiency, productivity, growth, rising incomes)

Too much state regulation Control inflation, limit debt, balance budgets Rely on private enterprise Free trade (reduce tariffs, barriers) Race to the top (countries integrate themselves into global economy)

Neoliberalisms critics
Leads to increasing inequality between and within countries Economic crises Environmental destruction Rationale for promoting interests of powerful individuals and corporations at expense of poor people and disadvantaged states Race to the bottom (countries compete to have lowest wages, taxes, fewest regulations to attract foreign investors)

Empirical record of neoliberalism

Uneven at best Chile a success story; most are not (e.g. Haiti) Many successful countries diverged from model (e.g., India, China, S. Korea, Taiwan) Even World Bank now concedes one-size-all prescription of balanced budgets, open markets, and privatization inadequate

Effects of Globalization

On developing countries
Rudra finds greater integration brought more job opportunities for workers in countries at all levels of development; workers in less developed countries at highest levels of economic development benefited most Effects of globalization on workers in less developed countries conditional upon countrys level of economic development and economic/political institutions

Consequences of globalization varies for developed countries as well

Exaggerated differences among them in terms of government spending as proportion of GDP, union density rates, provision of welfare

Various outcomes a function of different institutions and governing coalitions Some countries have political capacity to take advantage of globalization, others failed to develop it Only countries that have supportive institutions and governing coalitions can take advantage of it and ameliorate its effects

State Intervention: Fiscal Policy

Fiscal policy manipulation of budgets; overall revenues and expenditures

Budget deficits (spending more than revenues) enables states to increase money supply, demand for goods, business investment, and reduce unemployment Budget surplus (spending less than revenues) enables state to reduce money supply, cool economy, and reduce inflation States vary greatly in how much they tax and how much they spend States that tax more (capture larger proportion of GDP) have more influence over how national income is used and distributed in society; states that tax less have less influence over how income is used and who receives it

Monetary policy

Monetary policy manipulating rates of interest, cost of borrowing money

High interest rates discourage borrowing and spending (used to counteract inflation) Low interest rates encourage borrowing and spending (used to fight recession) Central banks issue currency and manage value in foreign exchange States vary in influence/control over central bank
Some are insulated from political influence (e.g., U.S.) Some are state controlled (e.g., China, S. Korea in 1970s)

Regulatory policy

Regulatory policy explicit rules of behavior that firms must follow (manage competition, set industry standards, require certain business practices)
States vary in how much they regulate firms to direct behavior Standard measure: number of days it takes to start a new business Another measure is labor relations (rules regarding relations between owners and workers) U.S. one of the least regulated in the world; American firms have significant power in deciding how to manage their workforce

Nationalization

Nationalization state-owned and controlled public enterprises

Enables states to control strategic assets, and to inject social criteria into economy
Examples: Mexico and oil industry (PEMEX); Chinas public enterprises (jobs/services)

States vary in degree of nationalization

Socialist states own and control all means of production (e.g., Cuba, N.Korea) More free-market systems have few public enterprises (e.g., U.S. and Chile)

States and Markets

Fiscal policy, monetary policy, regulations, and public enterprises only some of the ways states influence/intervene in the economy
In Japan, the state once promoted mergers and cooperation among firms to create firms large, efficient enough to compete internationally In Germany, the state has brokered agreements among union and employer organizations

Each country works out a balance between states and markets through political struggle In general, where markets play a greater role
States do not redirect as much of the countrys income through its budget
States do not exert much influence on central banks State regulations are not intrusive Public enterprises are small

When states play a more powerful role in determining who gets what
States redirect more of the countrys income through taxes and spending States exert greater influence over central banks States regulations are pervasive and directive Public enterprises control economys strategic industries

Markets and Capability

Market-based economies may improve capabilities a bit, but not consistently so

Democracy may be weak among state-led economies, but not necessarily strong among market-led ones Countries with market-led systems are not necessarily the most literate
Conditioned by intervening variables (religious and cultural norms)

Countries with market-led systems are no safer than those with state-led economies Market-based systems do appear to correlate with life expectancy, but with significant exceptions

Markets are not a panacea; must be supplemented to increase capabilities

Challenge: to develop a balance between states and markets that promotes best qualities of markets (innovation, productivity), while avoiding worst effects (instability, inequality)

What is the Washington Consensus?

The concept and name of the Washington Consensus were first presented in 1989 by John Williamson, an economist from an economic think-tank in Washington, D.C. The term Washington Consensus was used to summarize the commonly shared themes among policy advice by Washington-based institutions at the time such as the International Monetary Fund, World Bank, and the U.S. Treasury Department It was a set of Structural Adjustment Policies (SAPs)/economic policies which countries must follow in order to qualify for new World Bank and IMF loans and help them make debt repayments on the older debts owed to commercial banks, governments and the World Bank
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Why was the Washington Consensus developed?

The Washington Consensus was believed to be necessary for the recovery of Latin America from the financial crisis of the 1980s.

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There was once a Washington Consensus .

Augmented Washington Consensus the previous 10 items, plus: 11. Corporate governance 12. Anti-corruption 13. Flexible labor markets 14. WTO agreements 15. Financial codes and standards 16. Prudent capital-account opening 17. Non-intermediate exchange rate regimes 18. Independent central banks/inflation targeting 19. Social safety nets 20. Targeted poverty reduction

Original Washington Consensus

1.

Fiscal discipline 2. Reorientation of public expenditures 3. Tax reform 4. Financial liberalization 5. Unified and competitive exchange rates 6. Trade liberalization 7. Openness to DFI 8. Privatization 9. Deregulation 10.Secure Property Rights

What are the elements of the Washington Consensus?

There were 10 broad sets of recommendations
1.

2.

Fiscal policy discipline (This often result in deep cuts in programs like education, health and social care). Redirection of public spending from indiscriminate subsidies toward broad-based provision of key pro-growth, pro-poor services such as primary education, primary health care and infrastructure investment. (Many IMF and World Bank loans call for the imposition of user fees charges for govt-provided services like schools, health clinics and clean drinking water. For very poor people, even modest charges may result in the denial of these services). 21

What are the elements of the Washington Consensus? Cont.

Tax reform broadening the tax base and adopting marginal tax rates 4. Interest rates that are market determined and positive (but moderate ) in real terms (Higher interest rates exert a recessionary effect on national incomes, leading to higher rates of joblessness. Small businesses find it more difficult to gain access to affordable credit, and often are unable to survive). 5. Competitive exchange rates
3.
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What are the elements of the Washington Consensus? Cont.

6.

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 (the elimination of tariff protection for industries in developing countries often leads to mass layoffs. Eg. In Mozambique the IMF and World Bank ordered the removal of an export tax on cashew nuts. The result:10,000 adults, mostly women, lost their jobs in cashew nut-processing factories. Most of the processing work shifted to India, where child labourers shell the nuts at home).
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What are the elements of the Washington Consensus? Cont.

7.

Liberalization of inward foreign direct investment Privatization of state enterprises (SAPs call for the sell off of government-owned enterprises to private owners, often foreign investors. Privatization is typically associated with layoffs and pay cuts for workers in the privatized enterprises.

8.

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What are the elements of the Washington Consensus? Cont.

9.

10.

Deregulation abolition of regulations that impede market entry or restrict competition, except for those justified on safety, environmental and consumer protection grounds, and prudent oversight of financial institutions Legal security for property rights

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The Santiago Consensus

1. 2. 3.

Development must be market-based, but there are large market failures that cannot be ignored. Government should not be in the business of direct production, But, there is a broad, electric role for government in Providing a stable macro environment Infrastructure, though in few sectors than thought necessary in the past public health Education and training Technology transfer (and, for advanced LDCs, the beginnings of original R&D) Ensuring environmentally sustainable development, ecological protection providing export incentives. Helping the private sector to overcome coordination failures Ensuring shared growth acting to reduce poverty and inequality and ensure that as the economy grows, the poor share substantially in the benefits Continued if more moderate regulation and support in financial sectors Provision of fundamental public goods, such as legal structure, including the protection of property rights

Conclusion

The Washington Consensus took a one size fits all approach and failed to look at economic and cultural differences between countries which has not allowed for industrial deepening and structural transformation of many developing countries. Adjustment with a Human Face tried to address this by incorporating basic human concerns and seeing vulnerable groups as central objectives in economic growth and development. Without public action directed at the poorest and most vulnerable, there is no guarantee that economic growths and improvements in social indicators and poverty will automatically decline.
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