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Transcript of Beyond the Washington Consensus (Routledge Book)
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2
Introduction
The trade-development connection has been emphasised in the literature since the inception
of economics as a discipline. Adam Smith (1776 [1976: Bk. III, ch. 1, p. 405]), for example,
regards the evolution from agriculture to manufacturing and “last of all to foreign
commerce” as “the natural course” of development. This pattern of development goes on
through an increasingly intricate set of transactions between advanced (‘town’) and non-
advanced (‘country’) regions and between nations. In the latter case, foreign trade plays the
role of a vent for surplus home production, thereby promoting further division of labour and
greater accumulation of capital. Smith’s trade-development nexus highlights the principle of
absolute advantage in production. Technological progress (enhanced division of labour)
changes the pattern of absolute advantage, thereby enhancing the wealth of nations.2 The
“extent of the market” limits technological progress, hence the relevance of foreign trade
for bringing increasing returns to fruition. The economy, Smith argued, possessed unlimited
upward potential.
David Ricardo (1821), another classical political economist, held a more sceptical
view. He maintained that, since land rent grows as population increases, in the long-run
the economy follows a path toward a standstill. Ricardo’s model of international trade is
composed of two countries and two commodities; it laid out the theory of comparative
advantage, which argued that all countries could benefit from free trade, even if a
country lacked absolute advantage at producing all kinds of goods. Thus, even if, say,
country A is more proficient in producing both goods relative to country B,
international trade can profitably continue on the basis of comparative advantage.
According to Ricardo’s doctrine, countries reap gains from specializing in what they are
best at producing and trading with each other; hence foreign trade is beneficial at any
2To quote Adam Smith (1776 [1976, p. 7]: “The greatest improvement in the productive powers of
labour, and the greater part of the skill, dexterity, and judgement with which it is any where directed, or applied, seem to have been the effects of the division of labour”
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rate, albeit in the long-run increasing differential land rent will ultimately bring about
economic stagnation.
Building on Ricardo’s theory of comparative advantage, Eli Heckscher and
Bertil Ohlin elaborated a theorem maintaining that relative endowments of inputs
determines a nations’ both comparative advantage and trade specialisation, goods trade
and factor flow tend to be substitutes (cf. Ohlin, 1933). The theorem essentially says
that countries will export goods that utilize their abundant and cheap factor of
production and import products that utilize the countries' scarce factor. The policy
lesson that follows from the above is fairly straightforward: In order to attain higher
stages of economic development, under the assumption of international immobility of
labour and capital, a nation must specialise in the production of those goods that use
intensively the input that is relatively more abundant in the domestic market. The
Heckscher-Ohlin theorem became a basic constituent of the modern neoclassical theory
of international trade, which states that all countries benefit equally from (free) foreign
trade, regardless of the nature and quality of the goods being produced and exchanged
internationally.
After a long process of import substitution industrialisation –running roughly
between 1940-1980-, Latin America (and to a lesser extent Sub-Saharan Africa) adopted
a model of economic liberalisation in the late 1980s. The neoclassical theory of
international trade, in spite of its logical inconsistency (for example, capital as primary
factor has no method of measuring it before the determination of profit rate), became
the building-block of that “new” trade policy reform, encapsulated by the so-called
Washington Consensus (henceforth WC). The WC was said to represent a framework of
“good policies” of trade and financial liberalisation (Williamson, 1990). While the
Heckscher-Ohlin model gave the justification for trade liberalisation in the region in the
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aftermath of the 1982 foreign debt crisis, McKinnon’s theory (1973 and 1991) provided
the strategy for “the order” of financial liberalisation. The new orthodox approach to
economic affairs was adopted under the presumption that it would restore growth and
development on a sustainable basis, thus bringing about macroeconomic stability,
convergence to optimum growth and narrowing the outstanding development gap of the
Latin American economies vis-à-vis the leading economy in the world, the US
economy.
The essential questions to be tackled in this chapter are to inquire: whether the
WC strategy –original or “augmented”- contributed to bridging the development gap; in
what sense can it be argued that the decision –undertaken in the 1980s- of giving
markets free rein improved the performance of the economies under scrutiny if at all;
does the development process call for ancillary institutions? If the answer to the latter
question is in the positive, as experience appears to suggest (Cimoli et al., 2009; Chang,
2003 and 2008; Ffrench-Davis, 2005; Rodrik, 2004), one may ask whether industrial
policy can play a sensible role. We also expect to contribute to the current debate on an
alternative developmental paradigm for the Latin American emerging economies, an
urgent need dramatically prompted by the ongoing economic crisis. Our analysis is
focused on Argentina, Brazil, Chile and Mexico, the core economies of Latin America,
which altogether account for more than two thirds of the region’s GDP. China, today’s
fastest growing economy, is also included for the sake of comparison; the US economy
appears as a benchmark with a view of measuring the evolution of the development gap
of the involved countries before and after the inception of the WC model.
The chapter is organised in five sections in addition to this introduction. The first
section revisits the Washington Consensus framework and its policy implications for
economic development. The second section highlights the performance of some key
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macroeconomic variables before and after the reform. The next section discusses the
evolution of the development gap and the main driving forces behind its trend; the
fourth one makes the case for industrial policy from a developmental point of view and
the last section concludes.
I. The Washington Consensus Framework Revisited
The wide spread foreign debt crisis of 1982 was a major catalyst for change in Latin
America; the depth of the protracted crisis (and the stagflation that ensued) was
interpreted as the need for a new development strategy.
The Washington Consensus agenda was said to represent such an alternative
approach and, therefore, was adopted, in the late 1980s, under the presumption that it
would reignite fast and sustainable growth. The basic thrust of the original WC recipe
provided a fairly simple catalogue of policy changes that “were needed more or less
everywhere in Latin America” (Williamson 2004:1), namely fiscal discipline and
reorientation of government expenditure, tax reform, privatization of state owned assets,
deregulation, protected property rights, trade liberalisation, financial liberalisation
(indeed, liberalizing interest rates), openness to inward foreign direct investment and
unified and competitive exchange rates (Williamson, 1990). Getting a minimalist state
and prices right was the mantra of the new market-friendly approach to renewed
economic development. Even if it went unnoticed at the outset, the advent of the WC
implied the crisis of the developmental state that had been responsible, to a great extent,
for Latin America’s industrialisation in 1940-1980 (Câmara and Vernengo, 2004).
Indulgent fiscal policies leading to excessively large fiscal deficits were
considered as the root of high inflation, balance of payments disequilibria and exchange
rate instability. Moreover, the failure of import-substituting industrialization across the
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region was interpreted as associated to the deleterious effect of government intervention
through growing fiscal deficits. Many Latin American governments, seeking
macroeconomic stability and sustainable growth in the late 1980s, coalesced at their
own volition –combined with external pressure- on conducting market friendly reforms,
with the core countries Argentina, Brazil, Chile and Mexico successively excelling as a
poster child for the WC strategy. Ocampo (2004: 67) gives an account of the economic
reform worth quoting in full:
“Structural economic reforms varied in intensity across sectors and
countries. All countries in Latin America significantly liberalized
international trade, external capital flows and the domestic financialsector. Policy decisions in these areas included reducing tariffs and their
dispersion; dismantling nontariff barriers; eliminating most restrictions
on foreign direct investment; phasing out many or most foreign exchange
regulations; granting greater or total autonomy to central banks;
dismantling regulations regarding interest rates and credit allocation;
reducing reserve requirements on domestic deposits; and privatizing
several state banks.
In the fiscal area, reforms strengthened the value added tax, reduced
income tax rates and strengthened tax administration, though with only a
limited effect on tax evasion. Social security systems were overhauled in
several countries to allow for the participation of private agents and a
more clear balance between benefits and (employers’ and workers’)
contributions.”
The original agenda put forth by the WC strategy failed to live up to its goals; it
did not produce macroeconomic stability with sustainable growth as had been
predicated by its proponents, although Williamson (2004:8) warned, after fifteen years
of experience of free-market policies, “I have to admit that I too am uncomfortable if it
[the WC framework] is interpreted as a comprehensive agenda for economic reform”.
Indeed, while per capita GDP had increased by 2.7 per cent per year during 1950-1980,
the “lost decade” (the 1980s) saw a decline of 0.9 per cent annually and the WC era
produced a dull recovery of less than 1 per cent per year from 1990 to 2003 (ECLAC
2002 and 2003). What went wrong? Williamson (2003:2) maintains that “the
liberalizing reforms of the past decade and a half, or globalization, can [not] be held
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responsible for the region’s renewed travails in recent years.” The reasons accounting
for the failure are threefold, according to Williamson and Kuczynski (2003). First, while
pursuing macroeconomic stabilisation and microeconomic reforms practitioners of the
WC incurred misguided macroeconomic policies, such as procyclical fiscal policies and
exchange rate overvaluation, which left them exposed to capital reversals. Second, the
economic reform was incomplete; and third, the WC’s concern for accelerating growth,
alas, did not include equity.
Williamson and Kuczynski (2003) addressed these topics and proceeded to
propose a set of four second-generation reforms with the aim of restarting and ensuring
“future growth”. First, with regards the business cycle, countries must build up a
countercyclical policy intended for isolating their economies from adverse exogenous
shocks and reducing exposure to international financial markets volatility. In this view,
it is perfectly appropriate for the government to endorse the operation of the automatic
stabilisers and reject deflationary fiscal policies (like the one the current Mexican
government has followed, we may add) as a policy reaction to the present financial
crisis. The main elements of the proposed crisis-proofing or stabilisation policy are:
Sufficient ex ante accumulation of budget surpluses, of foreign exchange reserves and
stabilization funds in times of cyclical booms; adoption of a flexible exchange rate
regime and a monetary policy framework of (low) inflation targeting as a cushion
against perverse effects resultant from excessive capital inflows; forestalling liability
dollarization (the so-called original sin) and currency mismatch; reinforcement of
prudential regulation of the banking sector and, last but not least, improvement of
domestic savings rates. Interestingly, the volume edited by Williamson and Kuczynski
(2003: pp. 8, 77, 81, passim) endorses Maastricht-type debt and fiscal deficit rules in
order to enforce fiscal discipline in Latin America.
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Second, liberalizing reforms should be extended in order to make the labour
market more flexible. Excessive rigidity of the labour market “constitutes a major
obstacle to an expansion of employment in the formal economy” (op. cit.: 10).
Inflexibility of the formal labour market, it is argued, impairs acceleration of growth
and prevents a reduction of the informal sector, which employs “around 50 percent of
the manpower in many Latin American countries” (Williamson, 2004:11). The net
effect of labour market flexibilization is higher employment rates because it reduces
inequality of opportunity in the labour market (ibid.; Saavedra, 2003: 237-241, 252-
253).
Third, the need of building institutions. The original WC was oblivious of the
crucial role of institutions in the making of economic development, which is thoroughly
acknowledged in the augmented version. The type and quality of institutions suitable for
the enhancement of output growth and political stability, for the internalization of
externalities, for efficiently supplying public goods and correcting polarizing income
distribution, varies from one country to another. In this respect, the government is
allowed to play both the “old-fashioned” role of building a good productive
infrastructure and the modern role of “building a national innovation system” and
promoting R&D (Williamson and Kuczynski, 2003:12). The government can also
advocate institutional reforms aimed at enhancing property rights and prudential
regulation of the financial sector. While these reforms are not an easy task, if properly
designed they tend to reduce transactions costs and the risk premium.
Finally, governments should also have income distribution targets through
market-incentive mechanisms, i.e., through creation of new assets by providing poor
people with more human capital (education), secure property rights through land
reforms (in rural areas), microcredit lines (in rural and urban areas alike) and similar
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instruments that encourage civil society. The crucial tenet here is that these assets, when
combined within a sensible program, may represent a pro-poor growth strategy that
enables outcasts to work their way out of poverty (Williamson and Kuczynski, 2003:
14-18; Williamson, 2004:12).
II. Macroeconomic Performance Before and After the Structural Reform
The WC policy reforms prompted a radical change in the development strategy based
on perennial fiscal austerity3 and the laissez-faire paradigm (Davidson, 2003). As
pointed out, the WC famously promised that the replacement of the import-substituting
closed economy by a neoliberal open economy model in Latin America would lead to
renewed and accelerating economic growth on a more sustainable basis.
Economic Growth
The observed pattern of output growth varies from one country to another between 1960
and 2009. Yet, some common trends can be highlighted. Argentina, Brazil and Mexico
experienced episodes of growth accelerations from 1960 to 1980, albeit growth became
highly volatile in Argentina towards the late 1970s, perhaps owing to domestic political
instability and adverse oil shocks. Chile’s economic growth rate shows a downward
trend from 1961 to 1975 -with some good times in between-, and did not return to
growth rate levels observed in the early 1960s until 1985. The Chilean economy appears
to be an outlier in many ways: Import-substituting industrialisation was not as relevant
vis-à-vis other Latin American core economies; it adopted the laissez-faire approach to
economic development in the mid-1970s, i.e., during the first years of Pinochet’s
dictatorship. Chile’s per capita GDP increased over 3 per cent annually in 1980-2002,
3
The Washington Consensus view is that fiscal deficits crowd out private investment, cause recession,inflation and balance of payments crisis; hence the rejection of fiscal policy as a macroeconomic policyinstrument and hence the prescription of perennial primary surplus.
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while Argentina, Brazil and Mexico experienced negligible, even negative, growth rates
of per capita GDP. A noteworthy feature about Chile is that her approach to economic
reform has been way too more pragmatic than other countries’, taming liberalization
with capital and exchange controls and non-tariff restrictions for a certain period of
time.
Furthermore, beginning in the late 1980s the growth rate of the four core Latin
American economies exhibited a short-term upward trend that could not be sustained
beyond 1994. Thus, long-term economic activity became slower and more volatile after
the economic reforms. Contrary to Latin American countries, the Chinese economy, like
many other East Asian economies whose fate has not been subject to the WC agenda,
has been more vigorous and stable. If one looks at the more dynamic pattern of
behaviour shown by the Chinese economy in the last decades, one may ask, then, what
is the advantage of laissez-faire policies for latecomers? Summing up, both GDP and
per capita income slowed down in Latin America from 1960-1980 to 1981-2006,
whereas China, which kept away from the WC agenda, experienced long-term
sustainable growth accelerations (see Figure 1)4. While Latin America’s long-term
output performance has been stagnant, China has accumulated three decades of fast
growth.
4 Our data in Figure 1 are consistent with the growth patterns shown by Solimano and Soto (2004:2-3).They also assert “a substantial slowdown in economic growth after 1980” and identify a high number of “growth crises” (defined as negative growth rates). Solimano and Soto coincide with Titelman, Pérez-
Caldentey and Minzer (2008), who argue that while the average frequency of shocks to Latin America’sterms of trade diminished from six in 1980-1990 to two in 2002-2006; financial shocks became morefrequent between the 1980s and the 1990s. Most importantly, the latter’s magnitude increased from 0.7 per cent of GDP to 3.5 per cent. The authors conclude that during 1980-2006 adverse financial shocksclaimed domestic absorption adjustments equivalent to almost -7 per cent of GDP, whereas the impact of
terms of trade shocks on absorption declined from 2.25 per cent of GDP in 1980-1990 to 0.40 per cent in1991-2001 and 0.00 per cent in 2002-2006. Clearly, capital account liberalization has caused volatility of real economic activity to increase.
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Figure 1. Annual Growth Rate of GDP.
Inflation
Price stability through a flexible exchange rate regime and targeting a low rate of
inflation is another key condition for restarting growth5, according to Williamson
(2003). Inflation has been conquered in the region but, since monetary anchors had
5 “(...) low, stable inflation is important for market-driven growth, and (...) monetary policy is the most
direct determinant of inflation. Further, of all the government’s tools for influencing the economy,monetary policy has proven to be the most flexible instrument for achieving medium-term stabilizationobjectives” (Bernanke et al., 1999:3).
‐15
‐10
‐5
0
5
10
15
1 9 6 1
1 9 6 3
1 9 6 5
1 9 6 7
1 9 6 9
1 9 7 1
1 9 7 3
1 9 7 5
1 9 7 7
1 9 7 9
1 9 8 1
1 9 8 3
1 9 8 5
1 9 8 7
1 9 8 9
1 9 9 1
1 9 9 3
1 9 9 5
1 9 9 7
1 9 9 9
2 0 0 1
2 0 0 3
2 0 0 5
2 0 0 7
2 0 0 9
Source: Authors' calculations using data from The World Bank and the INDEC.
* Hodrick ‐ Prescott Filter: Smoothing parameter = 100.
Figure 1. Argentina: Annual Growth Rate of GDP, 1961 ‐ 2009.
Actual
Trend
‐5
‐3
‐1
1
3
5
7
9
11
13
15
1 9 6 1
1 9 6 3
1 9 6 5
1 9 6 7
1 9 6 9
1 9 7 1
1 9 7 3
1 9 7 5
1 9 7 7
1 9 7 9
1 9 8 1
1 9 8 3
1 9 8 5
1 9 8 7
1 9 8 9
1 9 9 1
1 9 9 3
1 9 9 5
1 9 9 7
1 9 9 9
2 0 0 1
2 0 0 3
2 0 0 5
2 0 0 7
2 0 0 9
Source: Authors' calculations using data from The World Bank and the IBGE.
* Hodrick ‐ Prescott Filter: Smoothing parameter = 100.
Figure 1. Brazil: Annual Growth Rate of GDP, 1961 ‐ 2009.
Actual
Trend
‐15
‐10
‐5
0
5
10
15
1 9 6 1
1 9 6 3
1 9 6 5
1 9 6 7
1 9 6 9
1 9 7 1
1 9 7 3
1 9 7 5
1 9 7 7
1 9 7 9
1 9 8 1
1 9 8 3
1 9 8 5
1 9 8 7
1 9 8 9
1 9 9 1
1 9 9 3
1 9 9 5
1 9 9 7
1 9 9 9
2 0 0 1
2 0 0 3
2 0 0 5
2 0 0 7
2 0 0 9
Source: Authors' calculations using data from The World Bank and the Banco Central de
Chile.
* Hodrick ‐ Prescott Filter: Smoothing parameter = 100.
Figure 1. Chile: Annual Growth Rate of GDP, 1961 ‐ 2009.
Actual
Trend
‐8
‐6
‐4
‐2
0
2
4
6
8
10
12
14
1 9 6 1
1 9 6 3
1 9 6 5
1 9 6 7
1 9 6 9
1 9 7 1
1 9 7 3
1 9 7 5
1 9 7 7
1 9 7 9
1 9 8 1
1 9 8 3
1 9 8 5
1 9 8 7
1 9 8 9
1 9 9 1
1 9 9 3
1 9 9 5
1 9 9 7
1 9 9 9
2 0 0 1
2 0 0 3
2 0 0 5
2 0 0 7
2 0 0 9
Source: Authors' calculations using data from The World Bank and the Banco de
México.
* Hodrick ‐ Prescott Filter: Smoothing parameter = 100.
Figure 1. Mexico: Annual Growth Rate of GDP, 1961 ‐ 2009.
Actual
Trend
‐30
‐25
‐20
‐15
‐10
‐5
0
5
10
15
20
1 9 6 1
1 9 6 3
1 9 6 5
1 9 6 7
1 9 6 9
1 9 7 1
1 9 7 3
1 9 7 5
1 9 7 7
1 9 7 9
1 9 8 1
1 9 8 3
1 9 8 5
1 9 8 7
1 9 8 9
1 9 9 1
1 9 9 3
1 9 9 5
1 9 9 7
1 9 9 9
2 0 0 1
2 0 0 3
2 0 0 5
2 0 0 7
2 0 0 9
Source: Authors' calculations using data from The World Bank and the National Bureau
of Statistics of China.
* Hodrick ‐ Prescott Filter: Smoothing parameter = 100.
Figure 1. China: Annual Growth Rate of GDP, 1961 ‐ 2009.
Actual
Trend
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failed to cope with rampant inflation, price stabilization necessitated a significant role of
managed pegs and exchange rate overvaluation. Actually, price stability predates the
adoption of an inflation targeting regime by central banks; in nearly all inflation
targeters inflation was already on a downward trend prior to the introduction of the new
monetary policy consensus (Rochon and Rossi, 2006). The median inflation rate in
Latin America went down from 32 percent to 14 percent between 1990 and 1994 (see
Figure 2).
Figure 2. Annual Rate of Inflation.
‐30
‐10
10
30
50
70
90
110
130
150
1 9 6 1
1 9 6 3
1 9 6 5
1 9 6 7
1 9 6 9
1 9 7 1
1 9 7 3
1 9 7 5
1 9 7 7
1 9 7 9
1 9 8 1
1 9 8 3
1 9 8 5
1 9 8 7
1 9 8 9
1 9 9 1
1 9 9 3
1 9 9 5
1 9 9 7
1 9 9 9
2 0 0 1
2 0 0 3
2 0 0 5
2 0 0 7
2 0 0 9
Source: Authors' calculations using data from The World Bank and the INDEC.
* Hodrick ‐ Prescott Filter: Smoothing parameter = 100.
Figure 2. Argentina: Annual Rate of Inflation, 1961 ‐ 2009.
Actual
Trend
‐50
‐30
‐10
10
30
50
70
90
110
130
150
1 9 7 0
1 9 7 2
1 9 7 4
1 9 7 6
1 9 7 8
1 9 8 0
1 9 8 2
1 9 8 4
1 9 8 6
1 9 8 8
1 9 9 0
1 9 9 2
1 9 9 4
1 9 9 6
1 9 9 8
2 0 0 0
2 0 0 2
2 0 0 4
2 0 0 6
2 0 0 8
Source: Authors' calculations using data from The World Bank and the Banco Central do
Brasil.
* Hodrick ‐ Prescott Filter: Smoothing parameter = 100.
Figure 2.
Brazil:
Annual
Rate
of
Inflation,
1970
‐2009.
Actual
Trend
‐10
10
30
50
70
90
110
130
150
1 9 6 1
1 9 6 3
1 9 6 5
1 9 6 7
1 9 6 9
1 9 7 1
1 9 7 3
1 9 7 5
1 9 7 7
1 9 7 9
1 9 8 1
1 9 8 3
1 9 8 5
1 9 8 7
1 9 8 9
1 9 9 1
1 9 9 3
1 9 9 5
1 9 9 7
1 9 9 9
2 0 0 1
2 0 0 3
2 0 0 5
2 0 0 7
2 0 0 9
Source: Authors' calculations using data from The World Bank and the Banco Central
de Chile.
* Hodrick ‐ Prescott Filter: Smoothing parameter = 100.
Figure 2.
Chile:
Annual
Rate
of
Inflation,
1961
‐2009.
Actual
Trend
0
20
40
60
80
100
120
140
1 9 6 1
1 9 6 3
1 9 6 5
1 9 6 7
1 9 6 9
1 9 7 1
1 9 7 3
1 9 7 5
1 9 7 7
1 9 7 9
1 9 8 1
1 9 8 3
1 9 8 5
1 9 8 7
1 9 8 9
1 9 9 1
1 9 9 3
1 9 9 5
1 9 9 7
1 9 9 9
2 0 0 1
2 0 0 3
2 0 0 5
2 0 0 7
2 0 0 9
Source: Authors' calculations using data from The World Bank and the Banco de
México.
* Hodrick ‐ Prescott Filter: Smoothing parameter = 100.
Figure 2. Mexico: Annual Rate of Inflation, 1961 ‐ 2009.
Actual
Trend
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However, exchange-rate-based stabilization becomes unsustainable in the long-
term because of the Impossible Trinity proposition: Governments cannot simultaneously
keep a fixed exchange rate regime, set the interest rate and have free capital mobility. At
the end of the day, when exchange rate crises erupt a nominal exchange rate anchor
must be abandoned. The Impossible Trinity helps to explain why Brazil, Chile and
Mexico moved from a variety of pegs to a flexible exchange rate regime cum inflation
targeting in the 1990s, while Argentina adopted a managed floating exchange rate
regime after the financial crisis of 2001 when its currency board was abandoned. Insofar
as the monetary-based anchor regime had gone astray in the 1980s and exchange rate-
based anchors had collapsed in the mid-to-late 1990s, the only monetary/exchange rate
regime left was a model that Knut Wicksell (1898) had originally put forth in which the
interest rate regulates the price level. This is the well-known inflation targeting
monetary policy framework advocated by the new monetary consensus (Bernanke et al.,
1999; Lavoie and Seccareccia, 2005).
The transition from the exchange rate-based anchor to the new monetary
consensus model was also facilitated by the recent developments in the international
capital markets (international securitization of investment instruments, financial
innovation, derivatives, financialization of the economic activity) which, in the last
analysis, led to the ongoing international financial crisis. Nonetheless, given the
‐5
0
5
10
15
20
25
1 9 8 7
1 9 8 8
1 9 8 9
1 9 9 0
1 9 9 1
1 9 9 2
1 9 9 3
1 9 9 4
1 9 9 5
1 9 9 6
1 9 9 7
1 9 9 8
1 9 9 9
2 0 0 0
2 0 0 1
2 0 0 2
2 0 0 3
2 0 0 4
2 0 0 5
2 0 0 6
2 0 0 7
2 0 0 8
2 0 0 9
Source: Authors' calculations using data from The World Bank and the National Bureau
of Statistics of China.
* Hodrick ‐ Prescott Filter: Smoothing parameter = 100.
Figure 2. China: Annual Rate of Inflation, 1987 ‐ 2009.
Actual
Trend
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influence of the volatility of perfect capital mobility on the dynamics of both the
domestic interest rate and the exchange rate, the very same transmission mechanism of
the international financial markets may powerfully influence the effectiveness of
developing countries’ monetary policy. As Rojas-Suárez (2003) put it, financial
liberalization has not guaranteed constant access to international capital markets.
Therefore, it appears that a framework composed of inflation targeting cum a flexible
exchange rate regime will not necessarily circumvent the constraints caused by the
Impossible Trinity nor will it automatically establish an independent monetary policy,
though a floating exchange rate will be a better trade shock-absorber than a peg.
Moreover, if inflation is not elastic to interest rate changes owing to distributive shares
(real wages and profit margins) are exogenously determined, in this case setting a low
inflation rate as the unique goal of monetary policy may impart negative effects on
capital accumulation, investment expenditure, output growth, the rate of employment
and income distribution (Palley, 1996; Oreiro et al., 2008).
In line with the discussion above, the high pass-through effect of exchange rate
fluctuations to the price level is a major reason that makes an arrangement of managed
exchange rate and flexible inflation targeting a superior regime than the one proposed
by the augmented WC (cf. Galindo and Ros, 2006; Ito and Sato, 2007). Again, as shown
in Figure 2, China achieved price stability her own way, as opposed to Latin America,
without surrendering herself to the constraints imposed on domestic monetary policy by
international capital markets and the Impossible Trinity.
Trade Liberalization and Trade Balance
Hoping to spur the level of economic activity, the core economies of Latin America
moved from import-substitution to trade liberalization in a short period of time. The
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trade-to-GDP ratio almost doubled between 1986 and 2006 as a consequence of rapid
expansion of exports and imports. Free trade in most cases meant severe import
competition for many industries that still were at the infancy stage and unable to cope
with trade liberalization.
Rodrik (2004) studied 83 growth accelerations events6 in the world economy between
1957 and 1992; he found that the bulk of those accelerations (82 percent) were not
brought about by economic liberalization. Remarkably, Latin America’s growth
accelerations of the post-war period were certainly unrelated to trade liberalization.
Some commentators have argued that, by and large, trade liberalization in Latin
America favoured rapid expansion of exports but at the same time the industrial sector
moved to static comparative advantages, while in China and East Asia manufacturing
upgrading allowed for dynamic advantages (Shaffaeddin, 2005). Most importantly,
trade liberalization in Latin America led to an export boom in activities characterized by
heavy imported inputs content. The export-led growth involved an import-led growth
model; the balance of payments constraint to long-term output expansion became even
more binding after trade liberalization as a result of the deterioration of the trade
balance (Moreno-Brid 1999; Pacheco and Thirlwall, 2006), although conjuncture
improvements in the terms of trade, owing to booming commodity prices such as
copper, soja and oil, produced temporary surplus positions which vanished over time.
The Chinese economy, instead, improved its current account position while opening to
foreign trade (cf. Figure 3).
6 Pacheco-López and Thirlwall (2006) summarize Rodrik’s concept of growth accelerations as a positive
discrepancy of 2 percentage points or more between eight years prior to the growth acceleration episodeand eight years after the event, with a post-acceleration growth rate of 3.5 per cent or higher.
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Figure 3. Trade Balance (% of GDP).
‐4
‐2
0
2
4
6
8
1 9 6 0
1 9 6 2
1 9 6 4
1 9 6 6
1 9 6 8
1 9 7 0
1 9 7 2
1 9 7 4
1 9 7 6
1 9 7 8
1 9 8 0
1 9 8 2
1 9 8 4
1 9 8 6
1 9 8 8
1 9 9 0
1 9 9 2
1 9 9 4
1 9 9 6
1 9 9 8
2 0 0 0
2 0 0 2
2 0 0 4
2 0 0 6
2 0 0 8
Source: Authors' calculations using data from The World Bank and the INDEC.
* Hodrick ‐ Prescott Filter: Smoothing parameter = 100.
Figure 3. Argentina: Trade Balance (% of GDP) 1960 – 2009.
Actual
Trend
‐8
‐6
‐4
‐2
0
2
4
1 9 6 0
1 9 6 2
1 9 6 4
1 9 6 6
1 9 6 8
1 9 7 0
1 9 7 2
1 9 7 4
1 9 7 6
1 9 7 8
1 9 8 0
1 9 8 2
1 9 8 4
1 9 8 6
1 9 8 8
1 9 9 0
1 9 9 2
1 9 9 4
1 9 9 6
1 9 9 8
2 0 0 0
2 0 0 2
2 0 0 4
2 0 0 6
2 0 0 8
Source: Authors' calculations using data from The World Bank and the IBGE.
* Hodrick ‐ Prescott Filter: Smoothing parameter = 100.
Figure 3. Brazil: Trade Balance (% of GDP) 1960 – 2009.
Actual
Trend
‐15
‐10
‐5
0
5
10
1 9 6 0
1 9 6 2
1 9 6 4
1 9 6 6
1 9 6 8
1 9 7 0
1 9 7 2
1 9 7 4
1 9 7 6
1 9 7 8
1 9 8 0
1 9 8 2
1 9 8 4
1 9 8 6
1 9 8 8
1 9 9 0
1 9 9 2
1 9 9 4
1 9 9 6
1 9 9 8
2 0 0 0
2 0 0 2
2 0 0 4
2 0 0 6
2 0 0 8
Source: Authors' calculations using data from The World Bank and the Banco Central
de Chile.
* Hodrick ‐ Prescott Filter: Smoothing parameter = 100.
Figure 3. Chile: Trade Balance (% of GDP) 1960 – 2009.
Actual
Trend
‐8
‐6
‐4
‐2
0
2
4
1 9 6 0
1 9 6 2
1 9 6 4
1 9 6 6
1 9 6 8
1 9 7 0
1 9 7 2
1 9 7 4
1 9 7 6
1 9 7 8
1 9 8 0
1 9 8 2
1 9 8 4
1 9 8 6
1 9 8 8
1 9 9 0
1 9 9 2
1 9 9 4
1 9 9 6
1 9 9 8
2 0 0 0
2 0 0 2
2 0 0 4
2 0 0 6
2 0 0 8
Source: Authors' calculations using data from The World Bank and the Banco de
México.
* Hodrick ‐ Prescott Filter: Smoothing parameter = 100.
Figure 3. Mexico: Trade Balance (% of GDP) 1960 – 2009.
Actual
Trend
‐4
‐2
0
2
4
6
8
10
12
14
1 9 7 8
1 9 8 0
1 9 8 2
1 9 8 4
1 9 8 6
1 9 8 8
1 9 9 0
1 9 9 2
1 9 9 4
1 9 9 6
1 9 9 8
2 0 0 0
2 0 0 2
2 0 0 4
2 0 0 6
2 0 0 8
Source: Authors' calculations using data from The World Bank.
* Hodrick ‐ Prescott Filter: Smoothing parameter = 100.
Figure 3. China: Trade Balance (% of GDP) 1978 – 2008.
Actual
Trend
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III. Evolution of the Development Gap
Structuralist economic theory emphasizes that economic development is basically
about structural change, therefore about growth and income distribution (Ros, 2000;
Taylor, 1991). There are many factors that can hamper structural change and capital
accumulation in a developing economy. These binding constraints often lead to a gap
between actual and optimum or desired growth rates of capital accumulation.
The structuralist literature has pointed out that “a gap signals macroeconomic
disequilibrium” (Taylor, 1991:159). The foreign debt crisis of 1982 and the ensuing lost
decade of the 1980s signalled a gap in Latin America. Economic liberalization and
market-oriented reforms were expected to remove such a gap (Rodrik, 2007). We now
turn to enquire whether economic liberalization has contributed to narrow the
development gap of a core set of Latin American economies and the most developed
economy in the world, namely the United States of America (USA). The development
gap for Latin America’s core economies is calculated in terms of the per capita income
of the country in question as a percentage of the USA’s per capita income. We assess
the performance of the development gap over the whole period 1960-2008, and
highlight the evolution of the gap before and after economic liberalization. Also, the
evolution of the gap of Latin America’s core economies is contrasted with that of China,
undoubtedly today’s fastest growing economy in the world.
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industrialization (henceforth ISI) made Brazil and Mexico better off. Yet, Argentina and
Chile do not appear to have improved their development gap in the ISI period.
The economic record of most Latin American countries after economic
liberalization is weak. Apart from Chile, none of them made great achievements during
1986-2008. However, the case of Chile should be looked at with caution because her
big-bang economic liberalization took place in the 1970s, in particular during 1973-
1982, clearly, an era when the development gap was on a widening trend. As a reaction
to the foreign debt crisis of 1982, the Chilean government reformed the liberal reforms
(Ffrench-Davis, 2005:149), tilting its trade policy towards a more pragmatic and
heterodox view (with exchange rate devaluations, antidumping measures, price bands
for some agricultural goods, the drawback system, the uniform tariff rate went up from
10 per cent to 35 per cent in 1984, capital controls and multiple exchange rates). So the
latter sub-period was not a laissez-faire environment altogether in this country.
According to Ffrench-Davis (2005), there was one radical trade reform in 1974-79 and
another moderate, more pragmatic reform in 1983-91. The first one produced a
widening development gap and the second one narrowed it.
As for Argentina, Brazil and Mexico, their development gap has widened, in
some cases very drastically with a fairly slight improvement towards the end of the
period under analysis. In contradistinction, China has continuously been catching up
vis-à-vis the US economy; China’s development gap has narrowed rapidly,
paradoxically, since it opened up to international trade.
What are the driving forces behind Latin America’s poor performance? Needless
to say, a number of factors call for the phenomenon. We argue that structural change in
Latin America has failed chiefly because the process of economic liberalization has
involved a low gross investment to GDP ratio and a drastic increase of the income
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elasticity of imports. Actually, in most Latin American countries the gross investment
ratio declined vis-à-vis the investment coefficient of the golden age of the ISI model. In
Argentina, seemingly the worst case, the gross investment coefficient peaked in 1977
(at 31% of GDP) and reached a minimum level in 2002 (12%). Brazil’s gross
investment ratio peaked in 1989 and has been on a downward trend ever since, whereas
the Chilean ratio exhibits an opposite (upward) drift from 1983 (9.8%) to 2009 (25%).
Mexico’s gross investment ratio has been low, on average around 20%, during the
whole economic reform period. In contrast, China’s fast long-term economic growth has
relied on a steadfastly upward drift of its gross investment ratio from the early 1960s
(10.8% in 1962) to the present time (close to 40%).
Figure 5. Gross Investment and Gross Savings (% of GDP).
10
15
20
25
30
35
1 9 6 0
1 9 6 2
1 9 6 4
1 9 6 6
1 9 6 8
1 9 7 0
1 9 7 2
1 9 7 4
1 9 7 6
1 9 7 8
1 9 8 0
1 9 8 2
1 9 8 4
1 9 8 6
1 9 8 8
1 9 9 0
1 9 9 2
1 9 9 4
1 9 9 6
1 9 9 8
2 0 0 0
2 0 0 2
2 0 0 4
2 0 0 6
2 0 0 8
Source: Authors' calculations using data from The World Bank and the INDEC.
Figure 5. Argentina: Gross Investment and Gross Savings
(% of GDP), 1960 ‐ 2009.
GI
GS
10
15
20
25
30
35
1 9 6 0
1 9 6 2
1 9 6 4
1 9 6 6
1 9 6 8
1 9 7 0
1 9 7 2
1 9 7 4
1 9 7 6
1 9 7 8
1 9 8 0
1 9 8 2
1 9 8 4
1 9 8 6
1 9 8 8
1 9 9 0
1 9 9 2
1 9 9 4
1 9 9 6
1 9 9 8
2 0 0 0
2 0 0 2
2 0 0 4
2 0 0 6
2 0 0 8
Source: Authors' calculations using data from The World Bank and the IBGE.
Figure 5. Brazil: Gross Investment and Gross Savings
(% of GDP), 1960 ‐ 2009.
GI
GS
5
10
15
20
25
30
35
40
1 9 6 0
1 9 6 2
1 9 6 4
1 9 6 6
1 9 6 8
1 9 7 0
1 9 7 2
1 9 7 4
1 9 7 6
1 9 7 8
1 9 8 0
1 9 8 2
1 9 8 4
1 9 8 6
1 9 8 8
1 9 9 0
1 9 9 2
1 9 9 4
1 9 9 6
1 9 9 8
2 0 0 0
2 0 0 2
2 0 0 4
2 0 0 6
2 0 0 8
Source: Author's calculations using data from The World Bank and the Banco Central
de Chile.
Figure 5. Chile: Gross Investment and Gross Savings
(% of GDP), 1960 ‐ 2009.
GI
GS
10
15
20
25
30
35
1 9 6 0
1 9 6 2
1 9 6 4
1 9 6 6
1 9 6 8
1 9 7 0
1 9 7 2
1 9 7 4
1 9 7 6
1 9 7 8
1 9 8 0
1 9 8 2
1 9 8 4
1 9 8 6
1 9 8 8
1 9 9 0
1 9 9 2
1 9 9 4
1 9 9 6
1 9 9 8
2 0 0 0
2 0 0 2
2 0 0 4
2 0 0 6
2 0 0 8
Source: Authors' calculations using data from The World Bank and the INEGI.
Figure 5. Mexico: Gross Investment and Gross Savings
(% of GDP), 1960 ‐ 2009.
GI
GS
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Liberalization of the capital market, an important aspect of the market-oriented
economic reform, tends to produce higher interest rates. From a free-market perspective,
higher rates of interest for both lenders and borrowers are viewed as the automatic
balancing mechanism that equalizes desired saving and desired net investment. The rate
of interest sets free the dynamism that turns investment away from inferior projects so
as to promote technological progress and economic development (McKinnon, 1973 and
1991). Nonetheless, as Shackle (1983:154) points out, “the rate of interest arises from
uncertainty about the future prices of the bonds given by borrowers in exchange for
loans”. In such a case, the automatic balancing mechanism can be self-destructive. It
appears that under deregulated financial markets uncertainty increases the asymmetry
between the distribution of costs and benefits of capital account liberalization, on one
hand, and the level of economic and institutional development, on the other, becomes a
binding constraint: While the benefits of financial liberalization have a tendency to
increase beyond certain point, the costs associated to free capital flows tend to augment
below that dividing line (cf. Prasad and Rajan, 2008). The policy implication of this is
that the government ought to adopt a pragmatic view on capital account liberalization
rather than an overly laissez-faire approach. The asymmetric experience with capital
account liberalization across emerging market economies reveals that, while financial
liberalization in Latin America has given rise to cycles of ephemeral recovery and
10
15
20
25
30
35
40
45
50
1 9 6 0
1 9 6 2
1 9 6 4
1 9 6 6
1 9 6 8
1 9 7 0
1 9 7 2
1 9 7 4
1 9 7 6
1 9 7 8
1 9 8 0
1 9 8 2
1 9 8 4
1 9 8 6
1 9 8 8
1 9 9 0
1 9 9 2
1 9 9 4
1 9 9 6
1 9 9 8
2 0 0 0
2 0 0 2
2 0 0 4
2 0 0 6
2 0 0 8
Source: Authors' calculations using data from The World Bank.
Figure 5. China: Gross Investment and Gross Savings
(% of GDP), 1960 ‐ 2008.
GI
GS
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Rising trends of π for the Latin American countries can be detected during the
whole period of trade liberalization. Opposite to that, China has experienced a drastic
reduction in its π. The question arises as to why China has exhibited a declining income
elasticity of imports and an ever diminishing development gap, while Latin America has
experienced exactly the opposed trends in the period of the market-friendly reforms.
Before the WC agenda, the Latin American economies (Argentina aside) kept a
downward drift of π during 1960-1980; several growth acceleration episodes took place
along this period, despite the ISI had suffered from an anti-export bias. The WC
economic reform promoted an export-led growth model with outright import
liberalization. Unfortunately, the propensity to import has increased drastically since the
1980s, thus discouraging the positive effect of booming exports. Hence slow growth. In
contradistinction, China (and other East Asian economies) adopted an export-led growth
strategy that has triggered growth acceleration events largely because her government
prevented π from rising.
1
1.2
1.4
1.6
1.8
2
2.2
2.4
2.6
1 9 6 1
‐
1 9 7 6
1 9 6 3
‐
1 9 7 8
1 9 6 5
‐
1 9 8 0
1 9 6 7
‐
1 9 8 2
1 9 6 9
‐
1 9 8 4
1 9 7 1
‐
1 9 8 6
1 9 7 3
‐
1 9 8 8
1 9 7 5
‐
1 9 9 0
1 9 7 7
‐
1 9 9 2
1 9 7 9
‐
1 9 9 4
1 9 8 1
‐
1 9 9 6
1 9 8 3
‐
1 9 9 8
1 9 8 5
‐
2 0 0 0
1 9 8 7
‐
2 0 0 2
1 9 8 9
‐
2 0 0 4
1 9 9 1
‐
2 0 0 6
Source: Author's'calculations using data from The World Bank and the Penn World
Table.
Figure 6. Chile: Income Elasticity of Imports, 1961 ‐ 2007.
0.5
1
1.5
2
2.5
3
3.5
4
1 9 6 1
‐
1 9 7 6
1 9 6 3
‐
1 9 7 8
1 9 6 5
‐
1 9 8 0
1 9 6 7
‐
1 9 8 2
1 9 6 9
‐
1 9 8 4
1 9 7 1
‐
1 9 8 6
1 9 7 3
‐
1 9 8 8
1 9 7 5
‐
1 9 9 0
1 9 7 7
‐
1 9 9 2
1 9 7 9
‐
1 9 9 4
1 9 8 1
‐
1 9 9 6
1 9 8 3
‐
1 9 9 8
1 9 8 5
‐
2 0 0 0
1 9 8 7
‐
2 0 0 2
1 9 8 9
‐
2 0 0 4
1 9 9 1
‐
2 0 0 6
Source: Authors' calculations using data from The World Bank and the Penn World
Table.
Figure 6. Mexico: Income Elasticity of Imports, 1961 ‐ 2007.
1
1.5
2
2.5
3
3.5
4
1 9 7 9
‐
1 9 9 4
1 9 8 0
‐
1 9 9 5
1 9 8 1
‐
1 9 9 6
1 9 8 2
‐
1 9 9 7
1 9 8 3
‐
1 9 9 8
1 9 8 4
‐
1 9 9 9
1 9 8 5
‐
2 0 0 0
1 9 8 6
‐
2 0 0 1
1 9 8 7
‐
2 0 0 2
1 9 8 8
‐
2 0 0 3
1 9 8 9
‐
2 0 0 4
1 9 9 0
‐
2 0 0 5
1 9 9 1
‐
2 0 0 6
1 9 9 2
‐
2 0 0 7
Source: Authors calculations using data from The World Bank and the Penn World
Table.
Figure 6. China: Income Elasticity of Imports, 1979 ‐ 2007.
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The expectations of the policy of free markets and sound money, augmented
with “good governance” amendments, have not been fulfilled. The growth experience of
Latin America under the mainstream consensus, particularly if contrasted with that of
China or the successful East Asian economies, rejects the idea that the “Victorian” free
markets and sound money approach (Krugman, 1995) is the only and best recipe
available in town to economic development. Clearly, an alternative developmental
strategy for Latin America should be put in place. This “new” development program
needs not imply an a priori rejection of the export-led model. It must, nonetheless,
target a sensible reduction of π. The equation of the alternative developmental strategy
can be a strong pro-growth state plus strong market plus diminution of the balance of
payments constraint. There is plentiful historical evidence supporting the hypothesis
that nowadays’ advanced economies followed a similar path in which industrial policy
impelled growth and development (cf. Chang, 2003, 2008; Di Maio, 2009; List, 1841).
IV. Beyond the Washington Consensus: the Case for Industrial Policy
Williamson (2004: 14) admits that “of course we need to go beyond it [the Washington
Consensus]” because it “did not contain all the answers to the questions of 1989, let
alone that it addresses all the new issues that have arisen since then”. Williamson’s idea
of going beyond the WC advocates the need of institutional reforms, but he is too
willing to ignore the role industrial policy has played in the history of economic
development. He goes on to emphatically reject the adoption of industrial policy
whereby governments “pick winners.” Instead, a “cousin of industrial policy” is
welcome, namely a “Schumpeterian innovation […], a national system of innovation”
(Williamson, 2004:12) 9.
9“A national innovation system is about government creating institutions to provide technical education,
to promote the diffusion of technological information, to fund precompetitive research, to provide tax
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One may agree that a national system of technological innovation would
contribute to substantially improve Latin America’s economic performance, but it is
hard to see how Schumpeter’s approach to economic development, with its emphasis on
the role of the State and institutions as driving forces of the constitution of markets and
industrialization, can be made compatible with the microeconomic-behavior-based,
Washington consensus’s laissez-faire approach to growth. The latter assumes a minimal
government. The “new agenda” put forth in Kuczynski and Williamson (2003) and
Williamson (2004-5) acknowledges the importance of institutions, albeit it emphasizes
laissez-faire institutional reforms such as liberalization of the labor market,
privatization, asset titling and the stipulation of property rights. Interestingly, the new
agenda endorses countercyclical policies (allegedly) “à la Keynes” and improvements in
the region’s inequality in income distribution. The former requires targeting a budget
balance over the business cycle; the latter calls for policies aimed at increasing the
poor’s accumulation of human capital.
Unlike John Williamson, the recent Schumpeterian literature considers that
industrial policy does not necessarily thwart the market mechanism; an industrial
policy10, undertaken as a strategic collaboration or cooperative game between the
government and the market, is still viable and reasonable, in particular for the
enhancement of latecomers (cf. Aghion and Howitt, 2005; Cimoli et al., 2009; Dosi et
al., 1990; Rodrik, 2007). Industrial policy has been a built-in essential element of every
successful development experience (Cimoli et al., 2009). Williamson’s dismissal of
industrial policy runs counter historical evidence; developmental industrial policies
incentives for R&D, to encourage venture capital, to stimulate the growth of industrial clusters, and soon” (Williamson, 2004:11).10 Industrial policy is defined as a tool that targets specific industrial branches, sectors and firms with the
aim of enhancing productivity, rapidly catching up with technological leaders, increasing employment inthe formal labor market and accelerating output growth in line with some clearly defined nationaleconomic development goals (cf. Bresser-Pereira 2007; Cimoli et al., 2009; Rodrik, 2007).
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have played a fundamental role in the process of structuring the market and have been
part and parcel of institutional building in every historically observed catching-up
process of economic development. Importantly, macroeconomic policies must be
consistent with developmental industrial policy. As shown above, the free-market
reform has induced a deleterious effect on investment, the income elasticity of imports,
and the level of economic activity. The macroeconomic environment as represented by
the WC agenda involves supply-side incentives for entrepreneurship, but, paradoxically
enough, it has destroyed industrial production capacity and the domestic economies’
ability to absorb, adapt and apply technological capabilities (Castaldi et al. 2009). The
destruction of the domestic production chain is encapsulated in the recent sharp increase
in the income elasticity of imports, an unconstructive de-industrialization effect not seen
in the Chinese case11.
The indisputable fact that sometimes industrial policy have been prone to waste,
inefficiency and political corruption should not lead to the conclusion that industrial
policy never works. The market mechanism may also fail. Privatization in Latin
America and elsewhere has often given rise to picking wrong winners and crony
capitalism. As Rodrik (2007:151) correctly points out: “It is not true that there is a
shortage of evidence on the benefits of industrial policy […] it is difficult to come up
with real winners in the developing world that are not a product of industrial policies of
some sort.”
Industrial policy from this standpoint, challenges the principle of comparative
advantage as conceived by mainstream economics. Inasmuch as industrial policy
11As Khan and Blankenburg (2009:367) put it, “[…] the main effect of liberalization, across virtually all
of Latin America, has been to reinforce Latin America’s commodity bias in the absence of any attempts at‘Schumpeterian’ dynamic upgrading into higher-technology, higher-value added processes and/or
products. Put differently, technological improvements have been limited to certain basic commodities,such as copper concentrates in Chile or iron in Brazil, but no attempts have been undertaken to upgrade todifferent processes (copper smelting) or product (steel).” (Emphasis in the original).
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interacts with adequate institutions, it supplies public goods for improving technological
capabilities and knowledge accumulation. Historical experience confirms that in most
cases successful industrialization did not follow a path of productive sectoral
specialization according to the logic of comparative advantage (Imbs and Wacziarg,
2003). Instead, it revolved around industrial policies targeting the acquisition of
technological knowledge, highly skilled factors and capabilities that diversified the
composition of aggregate output away from given input endowments and from
“Ricardian” comparative advantages (Cimoli et al. 2009; Wood, 1995).
A Schumpeterian “cousin” of industrial policy, that is, a national system of
innovation presupposes that production occurs through a variety of institutions, namely
the firm, the market and the government. The existence of market imperfections,
externalities, public goods and increasing returns to scale furnish an economic rationale
for government interventions through industrial policies and regulation. An adequate
industrial policy can help reduce and bridge the technological and development gaps,
while regulation frameworks minimize the harmful effects of externalities that the
market mechanism either generate or is unable to internalize. Furthermore, it is hard to
think of such a national system of innovation without the role of a Developmentist State
acting to set up the clustering of diffusion processes of technological innovations
resultant from microeconomic behavior. The view that often the economic impact of a
technological innovation is particular and specific in nature is a central feature of
Schumpeter’s theory. Technical change remains within the realm of singular firms
and/or industries for a certain amount of time before it is spread over a wider
socioeconomic environment. If, owing to oligopolistic structures, asymmetric
information, differential access to new technologies or effective demand constraints, the
market mechanism itself fails to disseminate technical innovations over a broader
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dominion and at a faster speed, then public institution interventions can enhance
technological diffusion, boost the potential economic impact of technical change and
induce the multiplier effects of technical innovations, thus leading to higher growth
rates. Clearly, only a combination of both technical innovation and institutional
innovation can engender constellations of successful industrialization and economic
development. This is the manner in which Schumpeter’s dynamic approach (1934,
1942) envisaged the relevance of technological innovation in a theory of long-term
growth, which is far away, we may contend, from the augmented Washington
Consensus interpretation.
On the other hand, technological innovation increases productivity. Hence
changes the demand for labor per unit of output and the requirement of capital and
intermediate inputs in production. Therefore, aggregate supply and aggregate demand
change accordingly. The newly augmented productive capacity and the effective
demand must increase at the same rate, uniformly, for the economy to grow at full
employment and full utilization of actual productive capacity. However, by and large
demand and productivity grow at different pace across industrial sectors and in
aggregate terms, in which case economic growth will not necessarily involve full
employment. Technological innovation, therefore, in this scenario, produces structural
unemployment. The WC’s new agenda recommends labor market flexibility to cope
with unemployment and slow growth, under the presumption that flexible wages will
provide a full compensation mechanism of technologically-induced unemployment.
This hypothesis relies on the strong assumption of perfect and complete substitutability
of labor and capital. Nonetheless, a number of stylized facts associated to the
introduction of technological innovation rule out the prediction of endogenous
compensation induced by labor market flexibility as assumed by the new agenda:
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differential labor skills between displaced labor force and the new input requirements;
differential factor intensities between old and new products and industries;
heterogeneous capital; changes in the composition of GDP after the introduction of
technical innovation; price stickiness in goods markets and the presence of asymmetric
information in goods, labor and credit markets. All these stylized facts are pervasive
economy-wide. Therefore, labor market flexibility is no sensible solution to overcome
slow growth, structural unemployment, skewed distribution of income and social
inequality in Latin America.
Final Remarks
The Washington Consensus recommended microeconomic flexibility, macroeconomic
discipline and trade and financial liberalization as a rational method of surmounting
stagflation, exchange rate instability and balance of payments constraints.
The past 20 years have witnessed that countries that adopted the WC agenda
have performed poorly, and the economic prospect of Latin America in the context of a
world economy engulfed by a severe financial crisis is certainly not buoyant. Despite
the evidence of the last two decades, Williamson (2009:1) went on to state:
“The microeconomic advice that we have given and the report of the
Spence Commission are as valid as ever. It remains sensible to use rather
than fight the market, but to be prepared to alter a laissez-faire outcomewhen one of the classic conditions for market failure arises. These are:
when monopoly is unavoidable, when externalities are important, and
when the resulting income distribution offends social norms.”
The problem with the above conclusion is that such “classic conditions for
market failure” are ubiquitous in the modern economy; hence the need of an alternative
strategy. The question to be asked is where to go from here. We have made the case for
a developmental industrial policy. Another question to be raised is how to actually
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implement such a policy. The main thrust of the Washington Consensus is fiscal
discipline on the ground that budget deficits produce balance of payments crises. The
orthodox fiscal policy mix (primary fiscal surplus and nominal fiscal deficit) coupled
with high interest rates resulting from targeting low inflation, is responsible for the
stagnant economic path and the growing economic inequality observed over the last 20
years (Câmara and Vernengo, 2004-5:340, passim).
A developmental industrial policy calls for a radical change in the practice of
fiscal policy from the Washington Consensus concept of a primary surplus-dominated
macroeconomic discipline to a stabilizing-investment-based fiscal policy regime. There
is a fundamental contradiction in mainstream fiscal policy: in a context of financial
liberalization and inflation targeting, the primary surplus approach benefits bond
holders, reduces public investment, polarizes income distribution and hurts economic
activity. Hence Williamson’s refusal of industrial policy should not come as a surprise;
it is impossible to have both the primary surplus and developmental industrial policy
simultaneously.
A fiscal policy regime aimed at stabilizing investment, output growth, and the
labor market, congenial with developmental industrial policy, puts forth public
investment as the countercyclical tool par excellence. It needs not entail an explosive
accumulation of debt, provided the central bank targets low interest rates -Keynes’s
euthanasia of the rentier (Keynes, 1936:376)-, rather than low inflation, and provided
the monetary authority restricts capital movements12. This alternative policy framework
was known to Keynes in the 1930s, and appears to be consistent with Schumpeterian
technological and institutional innovation.
12
See also Câmara and Vernengo (2004-5) for a detailed discussion of the implications of Keynes’s pragmatic separation of the current budget and the capital budget in the practice of countercyclical fiscal policy.
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