What
John Williamson
Institute for International Economics
Chapter 2 from Latin
American Adjustment: How Much Has Happened?
Edited by John Williamson. Published April 1990.
Updated November 2002
© Institute for
International Economics
No statement about how to deal with the debt crisis in Latin
America would be complete without a call for the debtors to fulfill their part
of the proposed bargain by "setting their houses in order,"
"undertaking policy reforms," or "submitting to strong
conditionality." The question posed in this paper is what such phrases
mean, and especially what they are generally interpreted as meaning in
The paper identifies and
discusses 10 policy instruments about whose proper deployment
The
The 10 topics around
which the paper is organized deal with policy instruments rather than
objectives or outcomes. They are economic policy instruments that I perceive
"
There is at least some
awareness of the need to take into account the impact that some of the policy
instruments in question can have on the extent of corruption. Corruption is
perceived to be pervasive in
Fiscal Deficits
Differences of view
exist, however, as to whether fiscal discipline need necessarily imply a
balanced budget. One view is that a deficit is acceptable as long as it does
not result in the debt-GNP ratio rising. An even more relaxed criterion would
net off that part of the increased debt that has a counterpart in productive
public capital formation and simply seek to prevent an increase in the net
liabilities of the public sector relative to GNP. Another modification, which I
find persuasive although much of
The budget deficit has
traditionally been measured in nominal terms, as the excess of government
expenditures over receipts. In 1982
The exaggeration of
budget deficits by inclusion of the inflationary component of interest on
government debt is not the only inadequacy of public-sector accounting. Most of
the other questionable practices seem to involve understatement of the true
deficit:
- Contingent expenditures, such as the guarantees
given to savings and loan institutions in the
- Interest subsidies and some other expenditures are sometimes provided by the central bank
rather than from the budget.
- Privatization proceeds are sometimes recorded as
revenues rather than as a means of financing a fiscal deficit.
- The buildup of future liabilities of the social
security system is not included in budget outlays.
Despite the significant
differences in the interpretation of fiscal discipline, I would maintain that
there is very broad agreement in
Public Expenditure
Priorities
When a fiscal deficit
needs to be cut, a choice arises as to whether this should be accomplished by
increasing revenues or by reducing expenditures. One of the legacies of the
Reagan administration and its "supply-side" allies has been to create
a preference in
Much stronger views are
held, especially in the international institutions, about the composition of
public expenditures. Military expenditures are sometimes privately deplored,
but in general they are regarded as the ultimate prerogative of sovereign
governments and accordingly off limits to international technocrats.
Expenditures on public administration are recognized as necessary, although
sometimes they are believed to be unnecessarily bloated, especially where
corruption is out of hand. But there are three major expenditure categories on
which views are strongly held: subsidies, education and health, and public
investment.
Subsidies, especially
indiscriminate subsidies (including subsidies to cover the losses of state
enterprises) are regarded as prime candidates for reduction or preferably
elimination. Everyone has horror stories about countries where subsidized
gasoline is cheaper than drinking water, or where subsidized bread is so cheap
that it is fed to pigs, or where telephone calls cost a cent or so because
someone forgot (or lacked the courage) to raise prices to keep pace with
inflation, or where subsidized "agricultural credit" is designed to
buy the support of powerful landowners, who promptly recycle the funds to buy
government paper. The result is not just a drain on the budget but also much
waste and resource misallocation, with little reason to expect any offset from
systematically favorable effects on income distribution, at least where
indiscriminate subsidies are concerned.
Education and health, in
contrast, are regarded as quintessentially proper objects of government
expenditure (Balassa et al. 1986, chapter 4). They
have the character of investment (in human capital) as well as consumption.
Moreover, they tend to help the disadvantaged. This is an objective that fell
under a cloud in the early years of the Reagan administration, but that has
recovered its standing of the 1970s ("basic needs") in the late
1980s, aided by the prodding of UNICEF (Cornia,
Jolly, and Stewart 1987). Thus, the Managing Director of the IMF, Michel Camdessus, has declared the Fund to have a concern about
the impact of its programs on the poor, and more recently Barber Conable, President of the World Bank, has reasserted the
Bank's commitment to seeking to end poverty.2
Just how much help
expenditures on education and health in fact provide to the disadvantaged
depends on their composition as well as their level. Primary education is
vastly more relevant than university education, and
primary health care (especially preventive treatment) more beneficial to the
poor than hospitals in the capital city stuffed with all the latest high-tech
medical gadgets. This is not to say that there is no need for universities or
state-of-the-art hospitals: developing countries need to train and retain an educated elite as well as to raise the standards of the
masses and the poorest. But it is to assert that many in Washington believe
that expenditures need to be redirected toward education and health in general,
and most especially in a way that will benefit the disadvantaged.
The other area of public
expenditure that Washington regards as productive is public infrastructure
investment. There is of course a view that the public sector tends to be too
large (see the section on privatization below). However, that view coexists
with the view that spending on infrastructure that is properly within the
public sector needs to be large (and also that an industry should not be
starved of investment just because it is, however inadvisedly,
within the public sector).
Policy reform with
regard to public expenditure is thus perceived to consist of switching
expenditure from subsidies toward education and health (especially to benefit
the disadvantaged) and infrastructure investment. I would add that, for my
taste, the hostility toward subsidies tends to be too general. I fully sympathize
with the hostility toward indiscriminate subsidies, but I also believe that
there are circumstances in which carefully targeted subsidies can be a useful
instrument. Thus, my own test of a country's policies would not be whether it
had abolished all subsidies, but whether it could provide a convincing explicit
justification for those that remain in terms of improving either resource
allocation or income distribution.
Tax Reform
Increased tax revenues
are the alternative to decreased public expenditures as a remedy for a fiscal
deficit. Most of political
Despite this contrast in
attitudes toward the merits of increasing tax revenue, there is a very wide
consensus about the most desirable method of raising
whatever level of tax revenue is judged to be needed. The principle is that the
tax base should be broad and marginal tax rates should be moderate. This
principle, the basis of the 1986 reform of the
A particular issue that
arises in the Latin American context is whether an attempt should be made to
include within the tax base interest income on assets held abroad ("flight
capital"). By itself a single country's law subjecting such income to
taxation may not have much impact because of the problem of enforcement, but a
country is not even in a position to start discussions on enforcement with
haven countries until it has legislated to impose taxes on the interest from
flight capital (Lessard and Williamson 1987).
Achieving effective taxation of the income from flight capital is bound to take
a long time, but it would be interesting to know whether any countries have
embarked on the effort.
Interest Rates
Two general principles
about the level of interest rates would seem to command considerable support in
The question obviously
arises as to whether these two principles are mutually consistent. Under noncrisis conditions, I see little reason to anticipate a
contradiction; one expects market-determined interest rates to be positive but
moderate in real terms, although high international interest rates may make it
difficult to hold rates quite as moderate as might be desired. Under the sort
of crisis conditions that much of
The Exchange Rate
Like interest rates,
exchange rates may be determined by market forces, or their appropriateness may
be judged on the basis of whether their level seems consistent with
macroeconomic objectives. Although there is some support in
The test of whether an
exchange rate is appropriate is whether it is consistent in the medium run with
macroeconomic objectives (as in my concept of the "fundamental equilibrium
exchange rate," or FEER; see Williamson 1985). In the case of a developing
country, the real exchange rate needs to be sufficiently competitive to promote
a rate of export growth that will allow the economy to grow at the maximum rate
permitted by its supply-side potential, while keeping the current account
deficit to a size that can be financed on a sustainable basis. The exchange
rate should not be more competitive than that, because that would produce
unnecessary inflationary pressures and also limit the resources available for
domestic investment, and hence curb the growth of supply-side potential.
Growth of nontraditional
exports is dependent not just on a competitive exchange rate at a particular
point in time, but also on private-sector confidence that the rate will remain
sufficiently competitive in the future to justify investment in potential
export industries (for recent evidence, see Paredes
1989). Thus, it is important to assess the stability of the real exchange rate
as well as its level.
A competitive real
exchange rate is the first essential element of an "outward-oriented"
economic policy, where the balance of payments constraint is overcome primarily
by export growth rather than by import substitution. There is a very strongly
held conviction in
Trade Policy
The second element of an
outward-oriented economic policy is import liberalization. Access to imports of
intermediate inputs at competitive prices is regarded as important to export
promotion, while a policy of protecting domestic industries against foreign
competition is viewed as creating costly distortions that end up penalizing
exports and impoverishing the domestic economy. The ideal is a situation in
which the domestic resource cost of generating or saving a unit of foreign
exchange is equalized between and among export and import-competing industries.
The worst form of
protection is considered to be import licensing, with its massive potential for
creating opportunities for corruption. To the extent that there has to be
protection, let it be provided by tariffs, so that at least the public purse
gets the rents. And keep distortions to a minimum by limiting tariff dispersion
and exempting from tariffs imports of intermediate goods needed to produce
exports.
The free trade ideal is
generally (although perhaps not universally) conceded to be subject to two
qualifications. The first concerns infant industries, which may merit
substantial but strictly temporary protection. Furthermore, a moderate general
tariff (in the range of 10 percent to 20 percent, with little dispersion) might
be accepted as a mechanism to provide a bias toward diversifying the industrial
base without threatening serious costs. The second qualification concerns
timing. A highly protected economy is not expected to dismantle all protection
overnight. Views differ, however, on whether import liberalization should
proceed according to a predetermined timetable (the World Bank view, embodied
in many structural adjustment loans) or whether the speed of liberalization
should vary endogenously, depending on how much the state of the balance of
payments can tolerate (my own view, based on recollection of how Europe
liberalized successfully in the 1950s).
Foreign Direct
Investment
As noted above,
liberalization of foreign financial flows is not regarded as a high priority.
In contrast, a restrictive attitude limiting the entry of foreign direct
investment (FDI) is regarded as foolish. Such investment can bring needed
capital, skills, and know-how, either producing goods needed for the domestic
market3 or contributing new
exports. The main motivation for restricting FDI is economic nationalism, which
FDI can be promoted by
debt-equity swaps. Parts of Washington, perhaps most notably the US Treasury,
the Institute of International Finance, and the International Finance
Corporation, are strongly in favor of debtor countries facilitating debt-equity
swaps, on the argument that this can simultaneously further the twin objectives
of promoting FDI and reducing debt. Other parts of Washington, notably the IMF,
are much more skeptical. They question whether FDI should be subsidized; they
ask whether the subsidized investment will be additional; they argue that, if
it is not, the debtor loses by having its foreign debt reduced rather than
gaining free foreign exchange; and above all they worry about the inflationary
implications of adding to domestic monetary expansion.
Privatization
Debt-equity swaps
involve no monetary pressure when the equity purchased by the foreign investor
is bought from the government, in the course of an enterprise being privatized.
This is one attraction seen in privatization. More generally, privatization may
help relieve the pressure on the government budget, both in the short run by
the revenue produced by the sale of the enterprise and in the longer run
inasmuch as investment need no longer be financed by the government.
However, the main
rationale for privatization is the belief that private industry is managed more
efficiently than state enterprises, because of the more direct incentives faced
by a manager who either has a direct personal stake in the profits of an
enterprise or else is accountable to those who do. At the very least, the
threat of bankruptcy places a floor under the inefficiency of private
enterprises, whereas many state enterprises seem to have unlimited access to
subsidies. This belief in the superior efficiency of the private sector has
long been an article of faith in Washington (though perhaps not held quite as
fervently as in the rest of the United States), but it was only with the
enunciation of the Baker Plan in 1985 that it became official US policy to
promote foreign privatization. The IMF and the World Bank have duly encouraged
privatization in
The lack of a strong
indigenous private sector is one reason that has motivated some countries to
promote state enterprises. This is again a nationalistic motivation and hence
commands little respect in
My own view is that
privatization can be very constructive where it results in increased
competition, and useful where it eases fiscal pressures, but I am not persuaded
that public service is always inferior to private acquisitiveness as a
motivating force. Under certain circumstances, such as where marginal costs are
less than average costs (for example, in public transport) or in the presence
of environmental spillovers too complex to be easily compensated by regulation
(for example, in the case of water supply), I continue to believe public
ownership to be preferable to private enterprise. But this view is not typical
of
Deregulation
Another way of promoting
competition is by deregulation. This was initiated within the
The potential payoff
from deregulation would seem to be much greater in
Most of the larger Latin
American countries are among the world's most regulated market economies, at
least on paper. Among the most important economic regulatory mechanisms are
controls on the establishment of firms and on new investments, restrictions on
inflows of foreign investment and outflows of profit remittance, price
controls, import barriers, discriminatory credit allocation, high corporate
income tax rates combined with discretionary tax-reduction mechanisms, as well
as limits on firing of employees.... In a number of Latin American countries,
the web of regulation is administered by underpaid administrators. The
potential for corruption is therefore great.
Productive activity may
be regulated by legislation, by government decrees, and case-by-case decision
making. This latter practice is widespread and pernicious in
Property Rights
In the
That would be true, at
least, if
The other areas where
Washington's practice leaves much to be desired are exchange rate policy, where
the ill effects of the dollar's vast overvaluation of the mid-1980s still
linger even though the misalignment itself has been largely corrected, and
trade policy, which has made discouraging lurches toward protection despite all
the pledges to the contrary. in most of the microeconomic
areas—notably tax reform, FDI (so far, at least), deregulation, and property
rights—
Concluding Remarks
The economic policies
that
It is not at all clear
that the policy reforms currently sought by
As a second example, Dornbusch (1989a) has recently raised the question of
whether the
A third important issue
concerns capital flight. Fiscal discipline, positive real interest rates, a
competitive exchange rate, and more secure property rights are all important
for reversing capital flight. But it is doubtful whether all those reforms
together would lead to a prompt return of flight capital. Elimination of the
current tax incentive to keep money abroad would surely help too (Lessard and Williamson 1987), but this is certainly not a
policy on which Washington has yet reached a consensus, nor is it clear that
adding it would be enough to do the trick.4
Even though the
- Is the consensus shared in
- Have the recommended policies been implemented
in
- What results have been achieved where the
recommended policies have been implemented?
Those are the questions
that the country studies are being asked to address. Answering them will at
least help to clear the ground for examining what additional policies may be
needed to limit the transitional costs of inflation stabilization, to restore
growth, and to reverse capital flight.
One final reflection: A
striking fact about the list of policies on which Washington does have a
collective view is that they all stem from classical mainstream economic
theory, at least if one is allowed to count Keynes as a classic by now. None of
the ideas spawned by the development literature—such as the big push, balanced
or unbalanced growth, surplus labor, or even the two-gap model—plays any
essential role in motivating the Washington consensus (although I would fortify
my preference for varying the pace of import liberalization depending on the
availability of foreign exchange by appeal to the two-gap model). This raises
the question as to whether
References
Belassa,
Bela, Gerado M. Bueno, Pedo-Pablo Kuczynski,
and Mario Henrique Simonsen. 1986. Toward Renewed Economic Growth in Latin America. Mexico City: El Colégio de Mexico; Rio de Janeiro: Fundação Getúlio Vargas.
Brecher, Richard A., and Carlos
F. Díaz Alejandro. 1977. "Tariffs, Foreign Capital, and Immiserizing Growth." Journal of International
Economics (November).
Cornia, Giovanni Andrea,
Richard Jolly, and Frances Stewart. 1987. Adjustment with a Human Face.
Dornbrusch, Rudiger,
and Sebastian Edwards. 1989. "Macroeconomic Populism in
Lessard, Donard
R., and John Williamson, eds. 1987. Capital Flight and
Paredes, Carlos. 1989. "
Exchange Rate Regimes, the Real Exchange Rate, and Export Performance in
Polak, Jacques J. 1989.
Financial Policies and Development.
Shleifer, Andrei. 1989.
"Preconditions Necessary for the Recover of
Tanzi, Vito. 1989.
"Fiscal Policy and Economic Restructuring in
Williamson, John. 1985. The
Exchange Rate System. Policy Analyses in International Economics 5.
Notes
1. This
figure assumes a desire to stabilize the debt-GNP ratio, D/Y, at no more
than 0.4. Assume a real growth rate, ΔY/Y, of 0.04. Then ΔD/D
– ΔY/Y < 0 implies ΔD/Y < Y/Y
x D/Y = 0.04 x 0.4 = 0.016.
2. See,
for example, Camdessus' address to the United Nations
Economic and Social Council in
3. An
exception to the case for welcoming FDI can arise if the domestic market in
question is heavily protected, when the growth produced by foreign investment
can be immiserizing: see Brecher
and Díaz Alejandro (1977).
4. Some
might want to add the debt issue as a fourth topic on which it is not clear
that the
5.
Ironically,
The "
Doubtless I am most famous
for having coined the phrase "the Washington Consensus," which makes
me somewhat unhappy, partly because some reformers have taken this to suggest
that the main credit for reform lies in Washington rather than with them, and
partly because the term is so often used in an abusive sense markedly different
from that which I intended. I originally formulated what I termed the
Washington Agenda, or the Washington Consensus, in the background paper "What
Washington Means by Policy Reform" for a conference held by the
Institute for International Economics in November 1989, which was published as
the opening chapter in the conference volume The Progress of Policy Reform
in Latin America in 1990. My idea was to demonstrate to a
Unfortunately, my prosaic
list of policy reforms that could command a consensus (and I would argue that
there was more of a consensus about what needed to be done in 1989 than at just
about any other time in history—remember, this was when it was proclaimed that
history had ended) came to be interpreted as a policy manifesto for the
"neoliberal" right, or a revelation of what the Washington-based
international institutions were trying to impose on the rest of the world. My
reaction to these interpretations can be found in "Revisiting the
Washington Consensus," a paper I wrote for an IDB conference
just before I joined the World Bank (published in 1997 by the IDB in Louis Emmerij, ed., Economic and Social Development into the
XXI Century), and in What Should
the [World] Bank Think About the Washington Consensus? a
pa per I wrote for an internal World Bank conference in July 1999, and in Economic
Reform: Content, Progress, Prospects, a lecture delivered at the
In June 2002 I read Joe Stiglitz's new book Globalization and its Discontents,
and was sufficiently peeved with his populist usage of my term to write an
unsolicited review
of his book. Unlike many of his reviewers, I actually regard many of his
criticisms as quite substantive, but I still find his way of expressing them
unfortunate, and not only because of the personal attacks in which he is prone
to indulge. Late 2002 witnessed even more obituaries of the Wahington
Consensus than usual, so I was finally moved to ask "Did the
Washington Consensus Fail?" That was by way of a prelude to the book
edited by Pedro-Pablo Kuczynski and me called "After
the Washington Consensus: Restarting Growth and Reform in Latin America"
that was first released at the Annual Meeting of the InterAmerican
Development Bank in