Monday, January 17, 2005

Sweden and theWashington Consensus

Both Paul O'Mahoney and Stefan Geens link to a piece by Daniel Brook in Dissent magazine entitled "How Sweden Tweaked the Washington Consensus". It's mainly interesting, I think, for confirming Stefan's prejudice about leftists and their degree of understanding of economics. Here's the nut of the article:

Today the Swedish system is being challenged by a number of economic tendencies and forces commonly understood under the rubric of "globalization." ... According to this thinking, countries must embrace the "Washington consensus," the International Monetary Fund-backed policies of free trade, privatization, and lower taxes and public spending, in order to keep up with lean, mean developed countries such as the United States and rapidly growing economies such as China's.
Although Sweden has modified its economic arrangements, it has kept many features intact in defiance of the Washington consensus. More than half of GDP goes to the government as taxes (versus one-third in the United States). The extremely high level of taxation in Sweden funds a large public sector and an ambitious redistributive program.

The rest of the article is essentially variations on the theme: The Washington Consensus and the IMF would prescribe lower taxes for Sweden, but the country has kept them high and is still doing very well, thank you.

Unfortunately, despite putting the Washington Consensus right there in his headline, Brook seems not to have bothered to look it up. A few points are worth making.

Firstly, the Washington Consensus was always meant to be a set of prescriptions for developing, not developed, nations. While all countries might well benefit from adopting its strictures, developing ones would benefit more. At the heart of the Washington Consensus is fiscal discipline – this is especially important for developing countries which can't borrow at long durations in their domestic currencies. The result is that they load up on dollar debt, leaving themselves open to a classic asset-liability mismatch which can go disastrously wrong. (See Russia and Argentina.)

Secondly, nowhere in the Washington Consensus does it say that public spending should fall. In fact, given that the Washington Consensus was aimed at developing countries, it's almost taken for granted that public spending should rise: such countries are generally desperately in need of the social and physical infrastructure (schools, roads, electricity, etc) that is really the role of the state to provide.

In fact, far from asking for "lower taxes and public spending", the IMF and the adherents of the Washington Consensus generally ask for higher taxes and public spending. Maybe not an increase to Swedish levels, perhaps, but a country like Mexico, which collects just 14% of GDP in taxes, is constantly urged to bring that number substantially higher. There are certainly occasions where the IMF might target individual taxes which they consider to be invidious and deleterious to growth prospects – the financial transactions tax in Brazil is one example. But I would very much doubt that the IMF has ever recommended that any country seek to decrease the total amount of money that it raises in tax revenue – quite the contrary.

To be sure, one of the points of the Washington Consensus is tax reform. But tax reform in the context of development economics (which is what we're talking about here) does not mean the same thing as tax reform in the Grover Norquist sense of the phrase. When a development economist asks for tax reform, she's generally asking for:

More transparency and less complexity in the tax code;
An end to unfair tax burdens on certain individuals or businesses; and
A broadening of the tax base, so that as many people pay taxes as possible.

The problem is that when you want to raise taxes, it's much easier to simply go along to the state-owned oil company, say, or to a handful of rich businessmen, and tax them as much as possible, than it is to set up a transparent nationwide tax-collection system where everybody pays their own fair share. So incentives are distorted, tax collection remains low, and tax avoidance becomes epidemic. (See, um, Russia and Argentina.)

Where the Washington Consensus calls for lower marginal tax rates, it really does not have Sweden in mind. The point is to target tax regimes where the tax system results in people spending more effort on trying to avoid taxes than they do on work which actually benefits the economy as a whole. So long as tax avoidance is not a problem in Sweden, I doubt the IMF much cares what the highest marginal tax rate is.

It's worth bearing in mind that the Washington Consensus was developed as one tool to help bring billions of people out of poverty. Whether it worked or not can be (and is) debated ad nauseam. But the people who developed it – chiefly John Williamson, who is nobody's idea of a right-wing supply-sider – were trying to help build countries where the benefits of maximised economic growth were felt by the poor. The "government is bad and the less of it the better" rhetoric of US conservatives is nowhere to be seen in the Washington Consensus or in any IMF reports that I've seen.

I'm looking forward to the day when left-wingers learn to distinguish between neoliberalism and US-style tax-cutting conservatism. But judging by this article, that day is still a long way off.

Posted by Felix at 15:21 EST

Comments

The Washington Consensus has not even been really applied to emerging markets. The problem in East Asia was not suited for the same prescriptions as Latin America, and these countries could have done very well if the true Washington Consensus had been heeded, instead of following a misguided austerity program.

In 1997, Asian countries enjoyed current account surpluses and low fiscal budgets. There is very little welfare in Asia even now. Asian countries were informal followers of the Washington Consensus, as defined by John Williamson.

The problem was mismatched debt (indulging in massive long-term borrowing in US dollar-denominated securities), which developed because of the lack of any local bond market; coupled with corrupt and opaque financial regimes - the banking systems were in bed with ministers and tycoons, the stock markets were merely feeding investors' money to related, privately held companies.

The allure of the "Asian Miracle" created a bubble and everybody got burnt. The IMF saw a currency meltdown and Camdessus decided to apply the same medicine as given to Argentina and Mexico. But austerity wasn't what was needed; Asian needed to reflate and restructure. But instead interest rates were jacked up to stabilize currencies, creating severe recessions in many markets. Malaysia went the other way and pegged its currency to the dollar instead of hiking up interest rates, and indeed, its recession proved mild and short-lived.

The IMF is cast as the villain of the piece: it made this important mistake, but it was only cleaning up others' messes. The restructuring that followed was often painful but for those countries that embraced change, the crisis made them stronger. Malaysia has coddled itself for too long and is losing competitiveness. In the Malaysian case, it has deviated from the Washington Consensus, and it is now paying the price. Other countries were forced by the IMF to abandon sensible policy, making the crisis a lot worse than it had to be.

Posted by: Jame at 5:11 EST, January 18, 2005

John Kay in his recent book is interesting on this. He said it was this:

"the 'Washington consensus' is that well-defined private property rights, active capital markets, and free internal and external trade, are necessary and sufficient for economic success"

The point he would stress, and I agree, is that the political importance of it in the late 1990s was the 'sufficient' bit. The error was that its advocates had looked at what worked in the developed countries and drawn the wrong conclusions, i.e. private propery, active capital markets, trade were the explanation for economic success, when in fact they were the outcomes of economic success.

Posted by: Matthew at 12:04 EST, January 21, 2005

Maybe I misunderstood you, Matthew...what then would be the explanation for developed countries' economic success?

Posted by: Jame at 3:53 EST, January 25, 2005

I'd read John Kay's book 'The truth about markets', or in America, 'Culture and prosperity'. This Forbest interview is a good starter though, and his website johnkay.com, has lots of good articlse from the FT.

http://www.forbes.com/ceonetwork/2004/06/16/0616chat_transcript.html

Posted by: Matthew at 16:55 EST, January 25, 2005