Dani Rodrik's weblog

John Williamson and the Washington Consensus

John Williamson has a nice account of his relationship to the WC (his illegitimate child according to his daughter) in the Growth Commission's new blog.  Even since he christened the intellectual consensus of the late 1980s, Williamson has suffered from being identified with certain prescriptions that were neither in the original WC nor of his own liking.  In particular, he has never been an advocate of capital-account liberalization, has always favored intermediate exchange-rate regimes, and has had a pragmatic approach to privatization rather than a radical one. 

In fact, if John had not been the author of the WC, I suspect he would have been seen as one of the moderates on the developmental policy debates of our time, rather than as the proponent of a radical free-market approach.  I have never forgotten that when the Institute for International Economics was considering whether to publish my Has Globalization Too Far? (viewed by many as heretical at the time) John stood up and said he found nothing too crazy in it (he meant that as a compliment, I think). 

But it is a fact that his creation took an independent life of its own, and therefore became a legitimate target for critics like myself for what it came to represent.  In my own writings I have always tried not to implicate John himself directly with these ideas.  I hope John considers that I have succeeded.

On the substantive issues therefore, there is much less disagreement between John and I than people often imagine.  Here is a possible one:  

Several elements of my version of the Washington consensus were directed at providing market-oriented incentives: financial liberalization, trade liberalization (again), deregulation, and privatization. Dani Rodrik would, I think, argue that one can advocate the end without endorsing the particular means that I identified. In principle he may be right, but I find it difficult to envisage a market-oriented system in which loans are given to those endorsed by the state, imports require a quota, entry is limited to those who get approval, and the state is itself a competitor. It seems to me that once one joins him in recognizing a need for market-oriented incentives then one is pretty much committed to endorsing the means that I identified.

I would of course ask John to look at China or Vietnam before he concludes that market-oriented incentives preclude the heterodox arrangements he mentions in this paragraph.

But I do think John has a point when he criticizes me (and Stiglitz, who can of course speak for himself) for getting hung up on some of the details and not emphasizing the real big news in the WC:

The Washington consensus was not right wing in the sense that it advocated policies that would have jeopardized the interests of the poor. If it is now regarded in the way that many people appear to do then it inevitably will be a far more political manifesto than was intended. But that is no excuse for denying that the original consensus recognized a profound change in views of what was calculated to promote development. The irony is that critics like Stiglitz and Rodrik agree with the change of views but, for whatever reason, deny any change.

Of course, in my defense I can say that I have written a lot about how it is good that market incentives have come front and center in thinking about development (see here for example).  I can also complain that many renditions of my own views treat me as throwing out the market-incentives baby with the WC bath water.   But then I would sound like John, wouldn't I.

Which is why I can really commiserate with him. 

I should have read this book a long time ago

But better late than never, and in any case I doubt I would have appreciated it nearly as much as I do now: The Black Swan: The Impact of the Highly Improbable.

Four cheers for Paul Krugman

Three of them for having won (highly deservedly) the Nobel prize and one for having been a beacon of light and guidance during the latest crisis.  Many would have thought that his increasingly public role--and contempt for everything Republican--in recent years had diminished his chances, but the committee made the right choice.  Paul's contributions to international economics are legion.  His ability to cut to the heart of the matter with just a couple of equations is unparalleled in the profession. 

Some years ago I was at a Festschrift conference for Jagdish Bhagwati at Columbia--Paul's teacher at MIT and himself a frequently mentioned name in connection with the Nobel prize.  One of the speakers was Paul Samuelson.  Now the usual drill on such occasions is to toast the man of the moment with a combination of wit and eloquence.  I don't recall if Samuelson even mentioned Bhagwati.  What I recall is that Samuelson spent his whole time on a detailed exegesis of Paul's work on trade. I should have known then that if the Nobel committee were to give another prize in international trade, it would go to Krugman.  

Who killed Wall Street?

What will the post-mortem on Wall Street show? That it was a case of suicide? Murder? Accidental death? Or a rare instance of generalized organ failure?

But before we indict anyone, let's first remind ourselves how compelling the logic of the financial innovation that led us to our current predicament seemed not too long ago.

That is the topic of my latest column for Project Syndicate.   Read it here.

What a letdown

I really expected the G7 to come up with some new bold steps in their announcement this afternoon, including a bank holiday to allow some kind of triage as recommended by Nouriel Roubini.  But as Paul Krugman notes, G7 leaders have failed to face up to the challenge--once again.  There better be some surprise up their sleeve that they will reveal later. Otherwise we are really toast.    

Will globalization be reversed?

OK, I am re-reading The Economist (even a broken clock shows the correct time twice a day, right?) and in its latest issue Zanny Minton Beddoes gets the big picture right, I think:

Global integration, in large part, has been about the triumph of markets over governments. That process is now being reversed in three important ways.

First, Western finance will be re-regulated. At a minimum, the most freewheeling areas of modern finance, such as the $55 trillion market for credit derivatives, will be brought into the regulatory orbit. Rules on capital will be overhauled to reduce leverage and enhance the system’s resilience. America’s labyrinth of overlapping regulators will be reordered....

That leads to the second point: the balance between state and market is changing in areas other than finance. For many countries a more momentous shock over the past couple of years has been the soaring price of commodities, which politicians have also blamed on financial speculation. The food-price spike in late 2007 and early 2008 caused riots in some 30 countries. In response, governments across the emerging world extended their reach, increasing subsidies, fixing prices, banning exports of key commodities and, in India’s case, restricting futures trading. Concern about food security, particularly in India and China, was one of the main reasons why the Doha round of trade negotiations collapsed this summer.

Third, America is losing economic clout and intellectual authority. Just as emerging economies are shaping the direction of global trade, so they will increasingly shape the future of finance. That is particularly true of capital-rich creditor countries such as China....

The real important points here are 1 and 3, I think, while point 2 is a bit of a red herring.  What is striking about the government response to the food crisis is how little of it there has been on balance, rather than how much.  And Doha collapsed not because governments suddenly became enamored of protection, but because there was too little on the table for big countries like India and China for them to compromise on their offers.

But then Zanny follows up with the following, which reads almost like a parody of The Economist:

The big question is what lessons the emerging students—and the disgraced teacher—should learn from recent events. How far should the balance between governments and markets shift? ... Provocative as it may sound in today’s febrile and dangerous climate, freer and more flexible markets will still do more for the world economy than the heavy hand of government.

OK, I grant that "freer and more flexible" is better than "heavy handed" but that would be true regardless of what follows after these qualifiers.  This isn't analysis; it's ideology.

More ideas

The CEPR has put together a compendium of proposals from a mainly European group of scholars, edited by Richard Baldwin and Barry Eichengreen. 

No end to culprits

Martin Wolf has a nice account, appropriately titled "Asia's revenge," of how Asian surpluses played a key role in setting off the crisis.  It ends thus:

The crisis demonstrates that the world has been unable to combine liberalised capital markets with a reasonable degree of financial stability. A particular problem has been the tendency for large net capital flows and associated current account and domestic financial balances to generate huge crises. This is the biggest of them all.

Lessons must be learnt. But those should not just be about the regulation of the financial sector. Nor should they be only about monetary policy. They must be about how liberalised finance can be made to support the global economy rather than destabilise it.

This is no little local difficulty. It raises the deepest questions about the way forward for our integrated world economy. The learning must start now.

I couldn't agree more. 

But I think it is somewhat misleading to lay the blame for the crisis on global macroeconomic imbalances.  What causes a managable unwinding problem to turn into full-fledged crisis is not any net imbalance between saving and investment in Asia--or any corresponding current account deficit in the U.S.--but the gross amounts of indebtedness involved.  The problem in short is leverage, not a saving glut. That in turn is created by finance, not by macroeconomic imbalances or policies.  

What is to be done -– and by whom?

(I have found the following note by Avinash Persaud, circulated in an e-mail list, extremely useful and I am reproducing it here with his permission.)

by Avinash D. Persaud

There are five separate initiatives the authorities need to follow to contain the current credit crisis, reverse some of its effects and avoid it happening again. National authorities are best positioned to respond quickly to contain the crisis, international initiatives are required to avoid repetition and some combination of the two is best suited to reversing its effects.

National authorities can best contain the crisis through two measures. First, as Willem Buiter has argued they must revive inter-bank markets by providing a temporary guarantee for short-term unsecured lending between regulated institutions. Central bank disintermediation of inter-bank markets is more costly and less sustainable. Second, national authorities should also inject preference share capital to institutions that need it on condition of a partial swap of “old” debt for equity. Such involvement by government is best carried out arms length: in Europe’s case the EIB may be a good vehicle.

A critical part of the current crisis is that write downs of asset prices has so depleted bank capital that many banks are close to insolvency on a mark-to-market basis. These write downs are caused by the distress prices obtained when selling instruments today that the market cannot easily value because of their complexity and uncertainty over their rating. The third thing the authorities should do therefore is to support a more immediate reversal of this process by facilitating the creation of long-term liquidity pools to purchase assets – rather like John Pierpont Morgan’s 1907 money trusts. These pools are best managed by those with long-term liabilities like insurance companies and funds with investor lock ups, but the authorities could capitalize these liquidity pools through issuance of ten-year government bonds. Under existing rules these pools would not mark-to-market and it is better that long-term investors, not governments, are buying assets on a strictly commercial basis. These liquidity pools need to operate internationally and therefore need to be capitalized and organized internationally. The IMF may perform this co-ordination role.

This is the seventh international financial crisis I have lived through. At the end of each the focus on avoiding the next one has always been the same trinity: more transparency, more disclosure and more risk management. This is an inadequate response to systemic crises. At the heart of new, internationally co-ordinated regulatory initiatives, must be counter-cyclical capital charges a la Goodhart and Persaud. Crises do not occur randomly; they always follow booms. This is my fourth policy initiative. But there also needs to be shift in the focus of regulation, away from sensitivity to the market price of risk and notions of equal treatment for all institutions, to a greater sensitivity to risk capacity and a better appreciation that diversity is the key to liquidity. This is the fifth step. Systemic resilience requires different risks being held in places where there is a natural capacity for that type of risk. In the name or risk-sensitivity and equal treatment we ended up with institutions who had no liquidity, holding liquidity risk and those with little capacity to hedge or diversify it, owning credit risk.

Yes there is a plan C

And it has China at its center. Courtesy of Arvind Subramanian.