The Washington Consensus Revisited
A New Structural Economics Perspective
Justin Yifu Lin
National School of Development
Peking University
Overview of Presentation
• Introduction: the Failure of Washington
Consensus
• The New Structural Economics
• Viability, Development strategy and the
Endogenous Nature of Distortions in A
Transition Economy
• Viability and the Failure of Washington
Consensus
• Concluding remarks
2
INTRODUCTION:
THE FAILURE OF WASHINGTON
CONSENSUS
3
The Surprising Contrast of Transition
Performance in China/Vietnam and Eastern
Europe/Former Soviet Union
7
6
5
4
•
Figure 1： Transition Performance
(Per capita GDP in 1980=1)
E. Europe
F.USSR
•
China
– China and Vietnam followed a dual-track
gradual transition approach, which was
considered doomed to fail
– Eastern Europe and Formal Soviet Union
economies followed the Shock Therapy
based on the Washington Consensus,
which was considered to lead the
economy to a “J-curve” transition path
3
Vietnam
2
1
•
0
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008
After the transition started in the
earlier 1980s, China and Vietnam
continued to grow dynamically,
whereas the transition in Eastern
Europe and Former Soviet caused the
collapse and stagnation of their
economies.
The contrasting transition performance
was unexpected by economists:
The above failure of economists’
prediction suggests the needs for
rethinking the existing economic
theory of transition
4
THE NEW STRUCTURAL
ECONOMICS
5
Let’s go back to Adam Smith
• But not to The Wealth of Nations, which
reflects findings of Adam Smith’s research
• Let’s go back to Adam Smith’s methodology,
that is, An Inquiry into the Nature and Causes
of the Wealth of Nations
6
The Nature of Modern Economics
• The rapid, sustained income growth is a modern phenomenon
30,000
Western Europe
Western Offshoots
Eastern Europe
Former USSR
Latin America
Japan
Asia excl. Japan
Africa
25,000
20,000
15,000
10,000
5,000
0
1
1000 1500 1600 1700 1820 1870 1913 1950 1973 2001
• The nature of modern income growth is a process of continuous changes in
the structure of technologies, industries, and soft and hard infrastructure of
the economy
7
New Structural Economics
• An application of neoclassical economic
approach to study the determinates of
economic structure and its evolution in
development, which is the nature of modern
economic growth
• Why do I call this approach New Structural
Economics?
– By convention, it should be called structural
economics
– Add “new” to distinguish it from structuralism
8
What Determines Structure and its Change?
• The main hypothesis. Industrial structure is endogenous to endowment
structure, which is given at any specific time and changeable over time
– This is a new angle
– Most development policies failed because they neglect the endowments and its
structure
• Initial endowments. Determine the economy’s total budgets and relative
factor prices at any specific time, which in turn determine:
– Comparative advantage
– Optimal industrial structure (endogenous)
• Dynamics. Income growth depends on:
– Upgrading industrial structure
– Upgrading of endowments
– Improvements in “hard” and “soft” infrastructure
• Following comparative advantage (determined by the endowment structure)
to develop industries is the best way to upgrade the endowment structure
and to sustain industrial upgrading, income growth, and poverty reduction.
9
The Market and the State
• Firms maximize profits…choice of technology
and industries based on relative factor prices…
Need for a competitive market system
• Industrial upgrading and diversification needs
to:
– Address externalities
– Solve coordination problems
Need for a facilitating state
10
Stylized Facts of Successful Economies
• !3 economies achieved average annual growth
rate of 7% or more for 25 years or more in post
WWII
• According to the Growth Report, these
economies had the following stylized facts
–
–
–
–
–
Open and advantage of backwardness
Macro stability
High savings and high investment rates
Market economy
Proactive govenrment
11
NSE and The Growth Commission’s
Stylized Facts of Successful Economies
• Policy Recommendation from NSE
– Following comparative advantage
• Preconditions
• Market economy
• Facilitating State
• The results:
Growth Report
Stylized Facts:
– Openness and advantage of backwardness
– Competitiveness and strong external as well as fiscal
accounts: fewer home-grown crises and larger
scope for countercyclical fiscal policies.
– Large economic surplus and high returns to
investment: high rate of savings and investment.
#4
#5
#1
#2
#3
12
VIABILITY, DEVELOPMENT STRATEGY AND
THE ENDOGENOUS NATURE OF DISTORTIONS
IN TRANSITION ECONOMY
13
Viability and the Endogenous Nature of
Distortions
• Failed to understand the endogeneity of industrial structure to the
endowment structure, socialist economies as well developing countries
attempted to build up large-scale, modern industries which were too
far advanced compared to their countries’ level of development.
• The firms were non-viable in competitive markets and required
government’s subsidies and protections for their initial investment and
continuous operation through various distortions in factor/product
prices and government’s direct interventions in resource allocations.
• The distortions and direction interventions led to misallocation of
resources, rent-seeking, corruption, and political capture.
• After the initial investment-led growth, the socialist economies and
other developing countries were trapped in stagnation and frequent
crises.
14
VIABILITY AND THE FAILURE OF
WASHINGTON CONSENSUS
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Why the Washington Consensus Failed
• All transitional economies started with many nonviable firms in their old priority
sectors due to their comparative advantage-defying development strategy.
• The Washington Consensus failed to recognize that the distortions were
endogenous for the protection of nonviable firms in the priority sectors and
advised the government to eliminate all distortions immediately
– caused the collapse of old priority sectors and the subsequent social/
political instability
– Or for fear of the above consequence, the government reintroduced other
disguised protections and subsidies which were even less efficient
• The Washington Consensus also neglected the needs for the government to
play a proactive role in facilitating the entry into new sectors consistent with
the country’s comparative advantages.
16
Why Did the Dual-track Approach Succeed?
• The government continued to provide transitional support to nonviable
firms in the old priority sectors and removed distortions only when firms
in those sectors became viable or the sectors become very small.
• The government facilitated private firms’ entry to sectors that were
consistent with the country’s comparative advantage, which were
repressed before the transition.
• The dynamic growth in the new sectors created conditions for reforming
the old sectors. Firms in old sectors may become viable due to the rapid
accumulation of capital
•
The dual-track approach also resulted in the income disparity, rent-seeking, and wide
spread corruption, the remedy to those problems requires the completion of transition
from the dual-track economy to a well-functioning market economy
17
Concluding Remarks
• The Washington Consensus failed because it
did not recognize the endogeneity of
distortions in the transition economies
• It is imperative to incorporate the concept of
viability in neoclassical analysis
– To avoid over ambition in development policies
– To be pragmatic in policy reforms