The Cracking Washington Consensus

Starting in the early 1980s, fashionable opinion held that unfettered free markets, a reduced role for the state, and integration into the global economy provided the best formula for development. International financial institutions, the World Bank and the International Monetary Fund (IMF), pressed developing countries to conform to the formula as a condition of their loans. In policy circles, this formula came to be known as the “Washington Consensus.” Today the consensus is breaking up. Its legitimacy is declining in the face of slow economic growth, crippling instability in global financial markets, growing inequality, and the degradation of working conditions for large numbers of people.

Since 1980, economic growth rates for the developing world (with the exception of East Asia, which did not follow the Washington Consensus) have been much worse than in the two previous decades. A study from the Center for Economic Policy Research concludes that “there is no region of the world that the Bank or Fund can point to as having succeeded through adopting the policies that they promote—or in many cases—impose on borrowing countries.”

For more than a decade, the World Bank and the IMF have forced governments to open their stock and financial markets to short-term investments from the West. Capital poured in from pension and mutual funds, generating short-term growth. As a result, financial markets were dominated by sudden and rapid flows aimed at profiting from speculation. The growth in the scale of speculation relative to other transactions has been particularly pronounced in the foreign exchange markets. In 1971, just before the collapse of the Bretton Woods fixed exchange rate system, about 90 percent of all foreign exchange transactions were for the finance of trade and long-term investment; only about 10 percent were speculative. Today, those percentages are reversed; speculation makes up over 90 percent of all transactions.

The unregulated flow of private capital produces extreme volatility. In Mexico, foreign money, flowing massively into the country following implementation of the North American Free Trade Agreement (NAFTA) in early 1994, reversed course at the end of the year. Uncontrolled capital flight led to devaluation of the currency—and to a collapse of the economy that could only be halted through a fifty-billion-dollar rescue package led by the United States.

The crisis was short-lived for investors. But it had far-reaching effects on the Mexican people, reducing real wages for workers by 25 percent. The share of the population living on less than $2.80 a day increased to 38 percent.

The Mexican experience was repeated on a still larger scale in 1997, when another round of failing investor confidence, devaluation, and capital flight caused immense damage in a number of East and Southeast Asian countries. The worst-affected among them sustained huge losses: in 1998, Indonesia’s g...