IADB Conference on Development Banks Belo Horizonte March 31

Latin American Development and the post Washington Consensus Consensus

Joseph Stiglitz, Columbia University

I. CONTRASTING EXPERIENCES

• Rapid growth in Asia• Disappointment in the economies in transition

and Africa • And in Latin America

– Only limited growth• And it was not sustainable• And it was not sustained

– But even when growth did occur, it was not equitably shared

• Trickle down economics does not work• At best indifferent, and at worst hostile, to policies that would

have promoted equality

China’s growth is unprecedented

– Previous economic revolutions—like the industrial revolution of the nineteenth century—had seen growth rates peak at around 2 to 3%

– The golden age of growth in America in the fifties and sixties saw similar growth rates

– China’s growth has been three times these numbers

• Even faster than Asia miracle countries

BUT CHINA IS NOT ALONE

• India’s enormous success

• More than two decades of growth of 5 to 6%, now approaching 8%

And it’s more than just GDP

• China has had success not only in increasing GDP– The fraction of the Chinese population living

on less than $1 a day has fallen from 63.8% in 1981 to 16.6% twenty years later

II. THE MEANING OF SUCCESS

• We need to be careful in assessing what we mean by success

• US: GDP increasing, but– Increased poverty– And even those in the middle worse off—as real

median incomes falling– Real wages stagnating—incomes would have fallen

even more were it not that Americans are working more and more

• Imposing costs to the family• Huge social costs• Perhaps partially reflected in high level of violence and crime

—ten times higher than others

Meaning of success (2)– Poor performance in other indicators—health

• Spends more, poorer results• Lower ranking on HDI

– Growing problem: rich countries with poor people?• U.S. and elsewhere, GDP increasing, but environment worsening

– Will growth be sustainable?– Not only environmentally, but socially and economically– Especially with huge deficits

• Important not to be misled by using wrong measures of success– What we measure affects behavior– Do not be beguiled by GDP– Also look at HDI, median real income, Green NNP

• OBJECTIVE SHOULD BE SUSTAINABLE, EQUITABLE, DEMOCRATIC DEVELOPMENT

III. LATIN AMERICA IS NOT LIVING UP TO ITS OWN PAST—

and falling behind others

0

1

2

3

4

5

6

7

8

9

1961-1980 1981-1993 1994-2004

Brazil

East Asia

Latin America

DECLINING GROWTH IN PER CAPITA INCOME IN LATIN

AMERICA

-1

0

1

2

3

4

5

6

7

60s 70s 80s 90s 2001/2004

Brazil

East Asia

Latin America

GROWTH RATES: BRAZIL, CHINA AND INDIA

-6

-4

-2

0

2

4

6

8

10

12

14

16

90 92 94 96 98 2000 2002 2004

Brazil

China

India

LATIN AMERICA ALSO EXPERIENCED TREMENDOUS

VOLATILITY OF GROWTH

Growth in Latin America

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

1950s 1960s 1970s 1980s 1990s 2000-04

Source: WDI, World Bank and ECLAC

Unemployment in Latin America is relatively high

0

1

2

3

4

5

6

7

8

9

10

90 92 94 96 98 2000

Brazil

East Asia & Pacific

Latin America &Caribbean

There has not even been a catch up from the lost decade

1 9 6 1 - 8 0 5 . 5 9 %1 9 8 1 - 9 0 1 . 1 8 %1 9 9 1 - 0 1 3 . 0 5 %

1 9 6 1 - 9 0 4 . 1 0 %1 9 9 1 - 0 1 3 . 0 5 %

1 9 6 1 - 8 0 5 . 5 9 %1 9 8 1 - 0 1 2 . 1 5 %

S o u r c e : W D I W o r l d B a n k

I m p o r t - S u b s t i t u t i o n S t r a t e g y

V i e w i n g R e f o r m P e r i o d a s C a t c h - U p f r o m L o s t D e c a d e

T h r e e D i f f e r e n t V i e w s( A n n u a l A v e r a g e G D P G r o w t h R a t e )

V i e w i n g T h r e e P e r i o d s

V i e w i n g L o s t D e c a d e a s t h e A f t e r m a t h o f F a i l e d

POVERTY RATES IN LATIN AMERICA HAS NOT DECLINED

0

10

20

30

40

50

60

1981 1984 1987 1990 1993 1996 1999 2001

BrazilLatin AmericaEast Asia

IV. INTERPRETING THE FAILURES AND SUCCESSES

India’s success• In spite of weaknesses in infrastructure

– Including electricity– Better infrastructure would have led to even more

growth• In spite of absence of natural resources

– Or perhaps because• The “natural resource curse”

• Growth occurred before trade liberalization• And, like China, there is still not full capital

market liberalization

China’s success• IN SPITE OF IT NOT FOLLOWING MOST OF DICTATES

OF “CONVENTIONAL WISDOM” (WASHINGTON CONSENSUS)– Not even clear property rights

• But clearer property rights might have led to even more impressive growth!

– Large role of government• Including Industrial policy

– No free trade in earlier high growth period– No free capital market liberalization—even today

• SUCCESS BECAUSE THEY FOLLOWED A DIFFERENT AGENDA– Appropriate to their circumstances and history

• MUCH OF CONVENTIONAL WISDOM IS OFF THE MARK

China’s success (2)

• China’s success is not just because of its cheap labor

• Labor costs in textiles actually higher than many other developing countries

• Chengdu becoming software center

• Jilin –example of how to deal with “rust belt problems”

China’s 11th five year plan

• Two weeks ago, China adopted its 11th 5 year plan– Comprehensive approach to development– Emphasis on problems of inequality, and

especially in the rural area– Emphasis on the environment– And emphasis on science and technology,

maintaining competitiveness• Including establishing global class universities• A basis of independent innovation

THE EMERGING CONSENSUS

• THE WASHINGTON CONSENSUS WAS NEITHER NECESSARY NOR SUFFICIENT FOR GROWTH

• HAD A TOO NARROW FOCUS ON WHAT WAS MEANT BY SUCCESS– Ignored equity, democratic participation,

environment

EVEN ITS ECONOMICS WAS FLAWED

• CONFUSED MEANS WITH ENDS– Liberalization, privatization were means, not ends in themselves

• And even accounting was flawed– Numbers neither provided pictures of sustainability (balance

sheet) inflationary pressures– With enormous consequences, as privatizations were forced and

land reform and other social initiatives were thwarted

• FOCUSED ON PRICE STABILITY, NOT REAL STABILITY, GROWTH, EMPLOYMENT– Though high levels of inflation can be a problem

• FOCUSED ON TOO NARROW A SET OF INSTRUMENTS– Because the Washington Consensus did not understand the

limitations of markets, it focused on too limited a set of instruments it ignored:

• Land reform• Industrial policies• Strengthening the financial sector• Improving education• Competition policy• Governance issues in both the public and private sector

.

EVEN ITS ECONOMICS WAS FLAWED (cont.)

BASIC FRAMEWORK

• Need a balanced role for government– Market is at the center of the economy– But in every successful economy the government has

played a large role• In science and technology (internet)• In making markets work (sound banking and securities

market regulation• In protecting the environment• In maintaining social cohesion (income distribution, safety

nets)

• Countries suffer as often from too little government as from too much

Basic Framework (2):The importance of knowledge,

technology• We now recognize that what separates

developed from less developed countries is not just a gap in resources, but a gap in knowledge

• There is a limit to the pace at which you can close a gap in resources– Though China’s savings rate in excess of 42% helps

speed the process– But closing the gap in knowledge can occur at a very

rapid rate– That is why even a natural resource rich country like

Malaysia has, in the last two years, switched from focusing on investments in infrastructure to investments in people and research

The emerging consensus: trade

• Exports have played a role in the success of the East Asian and other high performing countries– Import liberalization can destroy jobs– New jobs aren’t automatically created– Trade liberalization in general has not been

associated with faster growth• Though obviously, autarky is not an option

Emerging Consensus: investment

• Creating a favorable investment (business climate) is essential– But some countries have done well without

foreign investment– One should probably not give preferences to

foreign investors– Short term capital flows do not result in higher

growth, investment– But do lead to more instability

• At the root of many of problems of last decade

Emerging consensus: privatization

• It makes sense for governments to focus on those areas where the markets, by themselves, fail to produce desirable outcomes– Externalities, like pollution—markets produce too

much– Externalities and public goods—like research and

social safety nets—markets produce too little– Income distribution—even if markets were efficient,

there may be excessive poverty, inequality

Privatization (2)

• But privatizations have often failed– Corrupt privatizations– Failure to regulate—monopoly pricing (even

better at exploiting consumers)– Agency problems

• And there have been some highly successful government enterprises– In many countries, industries– Chile, Korea, Malaysia

Emerging Consensus: Macro policy

• Of critical importance• Harder to manage macro-policy with fully open

capital markets• High exchange rates and high interest rates hurt

growth, employment• Puzzle

– Brazil’s overall performance has not been as strong as one would have thought from its strong export performance

– Explanation: excessively tight monetary and fiscal policies

Emerging consensus

• Importance of credit availability

• Importance of competition policy

• Importance of education– Both primary– Higher education

So where’s the controversy?

• Industrial policy, development banks– Not question of picking winners, but looking for

externalities, coordinating needed infrastructure investments, other investments

• The record has been mixed• Almost every successful country has had such

policies– Today, America’s is largely embedded in defense

department– But current American Administration is finally

recognizing importance for America to remain competitive, increased NSF budget

Brazil’s success

• Brazil has demonstrated technological leadership– Embraer airplane global best seller– Bio-fuels have helped Brazil achieve energy

independence– All done with important support from government

• Including through development bank (BNDES)

• These have resulted in impressive export performance– But why then has Brazil’s growth been so lackluster?

Controversy (ii)

• Institutions– Independent central banks focusing exclusively on

inflation…• America focuses on employment and growth• UK has government set inflation target• Sweden makes sure that voice of workers is heard

• Importance associated with various items– Equality/progressivity

• VAT is a regressive tax, and not even an efficient tax, in an economy with a large informal sector

• Land reform—– sharecropping introduces a major distortion in the economy– Most successful countries began with major land reforms

Controversies (iii)

• Credit—key role of making credit available at affordable interest rates

• Markets by themselves lead to undersupply in many areas

• In U.S., other successful countries—large role of government (guarantees, CRA)

• Foreign banks may lead to reduced supply to small and medium sized enterprises

• Important niche for Development Banks• High profits suggest lack of competition—what

should be done?

– What matters is both availability and lending rate (not just T-Bill rate)

• Greenwald and Stiglitz, New Paradigm in monetary economics

• Importance of reducing T-Bill rates and spreads• Regulatory policy, competition policy and standard

macro-economic policy instruments all have to be employed

-8-6-4-20246

(% of GDP)

Budgetbalance

Primarybudgetbalance

Currentaccountbalance

Fiscal and External Accounts in 2004

Country A

Country B

Which country looks in better shape?Which country looks like it should be growing faster?

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Country A Country B

Real GDP Growth

GDP growth (%)

What accounts for this growth differential?

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Country A Country B

Inflation (Consumer Price Index)

Inflation

It’s not inflation…

Can high real interest rates explain differences in performance?

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(%)

Inflation Real moneymarket

interest rate(ex post)

Real lendingrate (ex post)

Inflation and real interest rates (ex post) 2004

Brazil

Turkey

Excessively tight fiscal and monetary policies in Brazil?

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10.0020.0030.0040.0050.00

(%)

Exportschange

CAbalance

Budgetbalance

Reallendinginterest

rate

GDPgrow th

Brazil and Turkey, macro data 2004

Brazil

Turkey

Controversies

• Macro-policy– Too narrow a view of objective—controlling inflation

• Good policy also looks at growth and employment• Controlling inflation does not automatically lead to faster

growth• And indeed it may hamper long run growth

– Lower GDP now is associated with lower GDP long into the future

– Stabilization and growth policies are interconnected

• Relying on interest rates in crises limits use of debt• Weakens financial markets and impairs efficiency of

allocation of capital

BEWARE OF WASHINGTON CONSENSUS PLUS

• Lip-service to issues of distribution – better safety nets – or improved female education

• Emphasis on second generation of reforms– Items left off in earlier agenda

• In particular about governance issues

• Step in the right direction• But does not deal with fundamental

inadequacies in the current approach

V. Globalization will be imposing new challenges

• Heightened competition– Based on education, technology

• And heightened forces for inequality– Particularly problematic in countries, like

those of Latin America, where there is already high levels of inequality

• Will require an active role for government

Changing Global Landscape• Thomas Friedman has suggested that “the world is flat”—for first

time in human history, poor countries are competing on a level playing field

• But the world is not flat– Disparities between the haves and have nots have increased– Power of entrenched monopolies, like Micro-soft, is probably greater

than ever before– Importance of research gives enormous advantage to those who have

the resources and skills to undertake it– The Uruguay Round made the world less flat

• Especially TRIPs• But the nature of competition is enormously changed

– Successful countries cannot simply rest on laurels– And those coming from behind will have to work harder

• THESE CHANGES WILL AFFECT EVERYONE

The successful countries are shaping globalization, and winning

• Nordic countries have been so successful, not only in growth, but in broader measures of success– Readjusted their “welfare state” model to new realities– But still retained model—including high taxes– With better safety net, there can be more risk taking,

entrepreneurship• Success in modern technology based economies requires

risk taking

• There may even be less of an equity-efficiency trade-off than we once thought

VI. INSIGHTS FROM ECONOMIC THEORY

• The successful countries have actually followed models which are more in accord with economic theory than the Washington consensus

• They have recognized the importance of MARKET FAILURES

MARKET FAILURES IN DEVELOPING COUNTRIES

• Problems are particularly significant in developing countries

• Markets also by themselves do not produce efficient outcomes when technology is changing or when there is learning about markets – Such dynamic processes are at the heart of development– There are important externalities in such dynamic processes – Giving rise to an important role for government

• Successful East Asian countries recognized this role– The Washington Consensus policies did not

WASHINGTON CONSENSUS AND EQUALITY

• Justifications for ignoring equity– It was argued that one could separate equity and

efficiency considerations, and economics should just focus on efficiency

– Trickle-down economics meant that the poor gain if growth is pursued and attained

– There were really no “trade-offs”- the single best policy would benefit everyone

• Could essentially leave economic policymaking to technocrats to find that “best policy”

PROBLEMS WITH THESE JUSTIFICATIONS

• These arguments are neither theoretically or empirically correct• Modern theories emphasize that equality and efficiency cannot be

separated– Agency theory– The arguments for land reform

• Sharecropping attenuates incentives just as taxes do• Washington Consensus policies did serve the interests of

technocrats– And established special interests

• Too much faith in markets– Even under the best of circumstances, there is no reason to believe

markets are consistent with social justice– But even if one did not care about equity, distribution of income, there is

an important role for government because of market failures

Equity is an “end” in itself

• But equity promotes growth and even efficiency– Better use of human resources– Social and political sustainability

VII. A Social Democratic Agenda

• Premised on the belief that those in Latin America know better what they want—and how to get it—than those in Wall Street or Washington or elsewhere– Though they should seek advice, experience of others– And they need to take into account reactions of others

• And what they care about puts weight on democracy, the environment, health, poverty, values besides increases in GDP– Puts people first– Both as the means of success—and the objective of success

A Competitiveness/Growth Strategy which puts people and values first

1.Enhancing Competition– Requiring strong anti-trust laws– Strong regulations of natural monopolies

2. Strengthening the public sector (reinventing government)

– Strengthening progressive taxation– Less reliance on V.A.T.– More taxation of oligopolies

– Increasing transparency• One of great achievements of current Administration

– Benchmarking efficiency

A Competitiveness/Growth Strategy (ii)

3. Putting people first– Investments in education, health– Land reform– Strengthened safety nets

4. Pro-growth policies– Expanding credit– Maintaining a pro-growth macro-policy– Industrial/export promotion policies at national and

state level• Including investments in advanced education and research

Latin America faces a choice

• The policies just described have worked– In Asia, in the Nordic countries– They can work in Latin America as well

• Latin America has a choice between two strategies– One has not been working well in Latin

America or elsewhere– Failed in promoting well-being of ordinary

citizens

Latin America faces a choice (2)• The alternative strategy—pursued in much of Asia-- has worked

well, beyond the wildest expectations– Though any strategy has to be adapted to local conditions; one size fits

all policies do not work• Fifteen years ago there was considerable uncertainty about the

relative merits of alternative strategies– Enormous successes and failures has now brought clarity– Though in many circles ideology/interests still prevail– Success of alternative model consistent with modern economic theory,

with its recognition of the strengths and limits of markets• Hopefully, the countries of Latin America will choose the strategy

which is not only likely to enhance economic growth– But also will have a greater chance of ensuring that the benefits of that

growth are shared widely among the people of the region

CONCLUDING REMARKS (i)

Elements of the Post Washington Consensus Consensus

• Importance of equity• Importance of employment• Balanced role of government and market

– Promoting and regulating markets– Providing institutional and physical infrastructure– Promoting education, innovation and technology– Providing social safety net, redistribution

MORE THAN THEORY

• The ideas are not just of academic importance, but are of relevance to every major aspect of public policy

• Development is possible, but clearly not easy• Equitable, sustainable and democratic

development may even be more difficult• Policies do matter• The intellectual framework for thinking about

policies provided by the Washington Consensus was badly flawed

Concluding Comments (ii)

• There are other frameworks– More rooted in economic theory– And historical experience– Which, at least in other countries, have

worked better• Faster, more sustainable growth• More equitably shared

• These provide the basis of the Post Washington Consensus Consensus