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01/2005 		 

A farewell to old doctrines

There is no blueprint for economic growth and poverty alleviation. Developing countries need customised strategies, which take their specific situations into account. The World Bank and other multilateral institutions have taken leave of the rigid rules of the old “Washington Consensus” – but further reforms are still necessary.


[ By Heidemarie Wieczorek-Zeul ]

The economic policy recommendations dominant in the 1980s and 1990s, such as the so-called structural adjustment programmes of the World Bank and IMF, have failed. Core elements of the strategy known as the “Washington Consensus” were extensive liberalisation, deregulation and privatisation, along with a supposedly “neutral” fiscal and monetary policy.
The Cologne Initiative, launched by Germany’s Federal Government in 1999, succeeded in breaking with old dogmas. Strategies for the alleviation of poverty replaced the traditional approach of structural adjustment. A key aspect of the new approach was that recipient countries were to design their own policies (“ownership”) and to involve civil society in doing so (“participation”). The mould of traditional, standardised reform packages was broken and a new culture open to alternative policies was established.

The new approach has now been applied to 54 developing countries. In many cases, it resulted in the concerned nation’s first ever experience of widespread public policy debate. That, in itself, was a major step forward, not least because it led to greater inclusiveness. Moreover, the new approach made it possible to propose and debate various options of dealing with economic, social and socio-political issues. On top of that, attention focussed on poverty alleviation.

Last September, the introduction of the new World Bank guideline entitled “Development Policy Lending” was a further important milestone. This new policy has officially replaced structural adjustment. Evidently, the reform is about more than merely changing labels. The idea is to become more responsive to alternative approaches and to local solutions. The Bank has acknowledged that there is no universal blueprint for structural reform in all partner countries. Reform policies can only be developed in the context of each individual case.

Nonetheless, the policies of the Bretton Woods Institutions continue to suffer from some major flaws. Economically, they have not yet succeeded in developing concrete formulas to promote growth with widespread benefits for the entire population. Insights – old and new – are not always taken heed of, nor does the principle of “ownership” consistently permeate day-to-day operations at the World Bank and the International Monetary Fund.

The question therefore remains, how economic growth can be boosted in developing countries, particularly in sub-Saharan Africa, to the extent needed for poverty levels to go down. Dynamic economic expansion is necessary, for, otherwise, many countries’ debt levels will prove to be unsustainable in the long term, and the millennium development goals will not be met. A report published by the German Development Ministry on these matters (BMZ 2004) has triggered a very constructive international debate.


Shortcomings of the “old” Washington Consensus

The traditional reform ideas of the 1980s and 1990s, generally known as the “Washington Consensus”, are ridden with many shortcomings, which can be summed up in three core arguments.

Firstly, the standard reform package of the “old” Washington Consensus included comprehensive, rapid privatisation as well as the deregulation of the economy and money markets. This market-driven approach has failed miserably, as has become evident in a number of developing countries. The traditional Washington Consensus fundamentally ignored the fact that these recommendations could not succeed in countries that lack the necessary framework of well-functioning institutions. Dynamic growth depends on efficient institutions supporting productivity increases and safeguarding a high degree of stability. In our context, the term “institution” applies to all social and political norms and regulations, as well as to all monitoring and enforcing instruments.

The second significant flaw of the “old” Washington Consensus was that it largely neglected issues of distribution. Today, we know that countries, in which wealth and income are relatively fairly distributed, on average report higher growth rates. So far, the implications of this insight remain largely unexplored.

The third weak point of the “old” Washington Consensus was the limited or passive role it allocated to macroeconomic policy. True to neoclassical doctrine, the Washington Consensus insisted on a supposedly neutral fiscal and monetary policy, concentrating exclusively on stabilising the economy. Macroeconomic policy can, however, play a pivotal role in promoting investment and economic growth.


Consequences for policy

It is, no doubt, difficult to draw generalised conclusions and make recommendations, which would apply equally to all developing and transformation countries. Nonetheless, international donors and the Bretton Woods Institutions in particular should take a number of lessons to heart.

For instance, there is no blueprint for development. We need tailor-made approaches. This has several implications:
– Developing countries must focus on institutional reform and the promotion of well-performing institutions in the sense elaborated on above. Deregulation measures are counter-productive if they occur without an appropriate institutional and regulatory framework.
– We need solutions, which are firmly anchored in the political, economic and cultural framework of the countries concerned, and which take their specific strengths and weaknesses into account. Greater attention must be paid to examining the specific context, in which each country’s institutions operate.
– Political capital and the ability to implement reforms are almost always strictly limited in poor countries. Consequently, reform programmes should always concentrate on those bottlenecks that are serious obstacles to development. This is exactly where reforms should start.
– The donor community and the partner countries cannot afford to dogmatically implement a reform agenda derived straight from theoretical reasoning. Less ideology, fewer ready-made formulas, more country-specific approaches and priorities are needed, as well as a dose of realism.


“Ownership” should be further enhanced

The HIPC Initiative and related poverty reduction strategies have fundamentally strengthened the responsibility of the developing countries involved. However, its full potential has not been tapped yet. Further comprehensive reforms are needed. At this point, it will suffice to mention only four major issues.

– Institutional reform and development: as there are no easy solutions, institutions such as the World Bank and the IMF should be prepared to play an advisory role on a wide range of policy choices. The international financial institutions must come up with country-specific, customised solutions rather than with “one size fits all” prescriptions.
– Better use should be made of the recipient countries’ analytic capacities, which, in turn, should be rigorously enhanced. This is the only way to discover economic options that correspond to specific situations.
– Experience has shown that conditionality is only meaningful when supportive of a country’s overall policy. What matters is the quality of any given programme. Detailed conditions do not help. Instead of defining political conditions we must move on to considering relevant result indicators.
At the same time, governments of developing countries should be given more voice in the Bretton Woods Institutions. After all, they are the ones who have to answer to their people. The developing countries – particularly the African ones – must gain greater influence on decision-making. I have already put forward some suggestions to the World Bank on this point.


Improved crisis prevention and debt sustainability

Relatively often, external shocks affect developing countries. On average, low-income countries record a so-called “commodity price shock” every 3.3 years. Sudden declines in world market prices for their main export products or sudden price-rises for major imports, such as crude oil, have far-reaching economic and social consequences. Debt levels tend to soar at the same time.

The World Bank should focus on crisis prevention. In particular, improving risk management and the way external shocks are dealt with are urgent issues. In order to reduce the vulnerability of countries, precautions should be taken to prevent situations, which might lead to an accumulation of unsustainable debt. In practical terms this means that borrowing by countries with low and moderate incomes should become more cautious. A “Debt Sustainability Framework” is needed for countries with a low income, to ensure that debt levels stay within certain limits. Many countries should receive a higher proportion of funding in the form of subsidies. The countries with moderate incomes should pay special attention to the structure and quality of their debts. Short-term volatile transfers cause problems because they increase vulnerability and favour an unbalanced debt structure (“mismatches”). For this reason, fast deregulation of capital transfers is not useful and ought to be avoided.

On the other hand, new funding tools should be considered. If possible, they should be designed in a manner minimising risks threatening the ability to raise the funds needed for debt servicing. For instance, interest payments on private creditors’ loans could be linked to GDP changes. Doing so would, in an economic crisis, prevent rapid deterioration of the debt servicing indicators and would make the creditors shoulder their share of the risk. In a similar way, the “servicing“ of concessionary credits from donors and development banks could be made more flexible. To eliminate exchange rate risks, official development assistance (ODA) credits could be made available in local currencies. The practicability of all these options should be investigated fast.


Drafting growth strategies

Development programmes must identify growth potentials more clearly and point out ways of harnessing them. To do so, more comprehensive strategies are needed. So far, too many poverty reduction strategies focus predominantly on social sectors rather than on the entire economy.

There is a gap between short-term budget planning and long-term development planning in developing countries. This gap must be closed. Otherwise, long-term approaches – and poverty reduction strategies along with them – will be doomed to fail. Bearing budgetary constraints in mind, specific poverty reduction strategies should be drafted and clear priorities set. The aim is to tackle existing bottlenecks in each country by applying focussed reform strategies.

Secondly, short-term macroeconomic planning (supported by the IMF) should pay more attention to long-term development goals. For instance, it should be permitted to exploit any fiscal latitude for additional spending on education, health and infrastructure without putting a country’s stability at risk. Evidence shows that fiscal guidelines have often been too restrictive in the past because the reaction of the private sector to such reforms normally did not turn out to be as positive as had been expected.

To illustrate this problem, let’s take Rwanda as an example. The macroeconomic situation of the country clearly worsened last year. This was partly due to the lack of rain, low coffee prices and rising oil prices. These events hit Rwanda – and many other African countries with similar economies – very hard. If Rwanda is to meet the development goals agreed upon at the international level, urgent investment in infrastructure, education and healthcare are needed. The macroeconomic guidelines must take into account that the purpose of such investment is not only to ensure that the millennium development goals are achieved. The idea is also to support growth, without which economic stability is usually unsustainable.


Concluding remarks

In all fairness, it should be said that it is not only the Bretton Woods Institutions, which are at fault. Other international organisations and national governments must also change their course. Current developments are moving in the right direction. A short time ago, the independent evaluation units of World Bank and IMF published their reports on the poverty reduction strategies. They support many of the viewpoints outlined above.

It is important that we continue to capitalise on the influence we have with the international institutions. It is a hopeful sign that we have already had some positive experiences. One of these is in the field of renewable energies. At our instigation, the World Bank recently decided to change policy fundamentally and to increasingly support renewable energy sources in future.






Information:
BMZ 2004: “Post-Washington-Consensus – A Few Thoughts”. The paper is posted on the web at http://www.bmz.de/de/service/infothek/fach/diskurs/index.html

An abridged version was included in D+C/E+Z in August 2004.

Heidemarie Wieczorek-Zeul
is the Federal Minister for Economic Cooperation and Development.
http://www.bmz.de