What is the Washington Consensus?

We frequently refer to the “Washington Consensus.” What is it?

Joseph Stiglitz, former World Bank Chief Economist and Nobel Prize-winner in Economics, offers a clear definition and explanation of Washington Consensus theory in his book Globalization and Its Discontents:

“Behind the free market ideology there is a model, often attributed to Adam Smith, which argues that market forces – the profit motive – drive the economy to efficient outcomes as if by an invisible hand. One of the great achievements of modern economics is to show the sense in which, all the conditions under which, Smith’s conclusion is correct. It turns out that these conditions are highly restrictive.

Indeed, most recent advances in economic theory – ironically occurring precisely during the period of the most relentless pursuit of the Washington Consensus policies – have shown that whenever information is imperfect and markets incomplete, which is to say always, and especially in developing countries, then the invisible hand works most imperfectly. Significantly, there are desirable government interventions which in principle, can improve upon the efficiency of the market …

“The Washington Consensus policies, however, were based on a simplistic model of the market economy, the competitive equilibrium model, in which Adam Smith’s invisible hand works, and works perfectly. Because in this model there is no need for government – that is, free, unfettered, ‘liberal’ markets work perfectly – the Washington Consensus policies are sometimes referred to as ‘neo-liberal,’ based on ‘market fundamentalism,’ a resuscitation of the laissez-faire policies that were popular in some circles in the 19th century. In the aftermath of the Great Depression and the recognition of other failings of the market system, from massive inequality to unlivable cities marred by pollution and decay, these free market policies have been widely rejected in the more advanced industrial countries, through within these countries there remains an active debate about the appropriate balance between government and markets…

The theory says that an efficient market economy requires that all of the assumptions be satisfied. In some cases, reforms in one area, without accompanying reforms in others, may actually make matters worse. This is the issue of sequencing. Ideology ignores these matters; it says simply move as quickly to a market economy as you can. But economic theory and history show how disastrous it can be to ignore sequencing.

The mistakes in trade, capital market liberalization, and privatization described earlier represent sequencing errors on a grand scale. The smaller-scale sequencing mistakes are even less noticed in the Western pres. They constitute the day-to-day tragedies of IMF policies that affect the already desperately poor in the developing world.”