The New Economic Policy Consensus Week 1 SF Intermediate Economics Professor Dermot McAleese

OUTLINE  The new consensus  Why policy has changed  Implications for the future  Will the consensus last?

THE NEW CONSENSUS  Competition and the market system  Macroeconomic stability  Globalisation

 openness towards international trade  limited government intervention in the economy, and  macroeconomic stability IMF, World Economic Outlook, May 1997, p 92 A Successful Strategy for Growth Requires:

COMPETITION AND THE MARKET SYSTEM  Pro-competition policies  Labour market flexibility  Privatisation  De-regulation  Enterprise-friendly environment

MACRO-STABILITY  Price stability (independent CB, ‘hard’ ER)  Budget balance  Control of government spending

GLOBALISATION  Free trade  Foreign investment  Liberalisation of capital  Labour mobility

GLOBALISATION  Open door policies (free trade, encourage foreign investment relax or abolish capital controls)  Extending the scope of international trade (agriculture, services, new issues)  Emphasis on export promotion (instead of import restriction)  Multilateral and regional trade agreements (Uruguay Round, WTO and Regional Trade Agreements)

WHY POLICY HAS CHANGED  Dissatisfaction with past performance  Lack of alternative paradigm -- failure of socialism  Government “failure”  Technology – external pressures

IMPLICATIONS FOR THE FUTURE  Business climate  lower taxes  weaker trade unions  rewards for managers, skilled workers  less government  but, more competition  Work environment  labour market flexibility  less job security  more jobs  structural adjustment and low cost countries  International economy  role of World Trade Organisation (WTO)  foreign investment and the multinationals  capital mobility and the shifting balance of economic power  mutuality of benefits

WILL THE CONSENSUS LAST?  Only as long as it delivers on faster growth  Convincing outcome for the developing countries will require:  correct sequencing of the new policies  consistent application of reforms  attention to income distribution  international cooperation and increased aid  State intervention at macro and micro level an essential complement to private sector

Moving towards the Post-Washington Consensus There are important advantages to the Washington consensus approach to policy advice. It focuses on issues of first-order importance, it sets up an easily reproducible framework and it is frank about limiting itself only to establishing prerequisites for development. But …. Policies advanced by the Washington consensus are not complete and they are sometimes misguided. Professor Joseph Stiglitz 1998

Incomplete In focusing on trade liberalisation, deregulation and privatisation, other important ingredients of an efficient market, most notably competition, were ignored. Add to this education and technology improvement. Government regulation of financial sector (building robust financial systems) is essential for effective market system – easily ignored by economists from developed countries Macro-stability should not preclude active use of fiscal and monetary policy to stabilise output and employment [controversial point]

Misguided Trade liberalisation over-estimated, importance of domestic competition ignored Benefits of privatisation over-estimated. Need for regulation and income distribution effects overlooked Capital liberalisation pushed too strongly Problem for developing countries is not too much government but not enough government capabilities (independent judiciary, competitive wages for civil servants, administrative and technical capacity, incentive systems in public sector).

The Central Bank and the New Consensus Irish GNP 3% 2002, 4 % in 2003 Ireland’s price level now substantially above that of the euro area In euro area, nominal pay rising 2.5% pa since In Ireland by over 8% (and 9% 2001) Competitiveness lost and job creation more difficult Fiscal policy (Irish) and monetary policy (ECB) have “facilitated” inflation -- especially in sheltered (“nontraded”) sectors of economy Major concern of macroeconomc policy is to reduce inflation rate to euro average

Policies Enforce competition Insist on greater price transparency Lower rates of pay increase, especially in the public sector, must be part of the disinflation process Allow automatic stabilisers to work But a discretionary stimulus is precluded by high inflation and the weaker budget position The primary task of fiscal policy must be to contain the excessive growth in public spending (p.8) Central Bank of Ireland Quarterly Bulletin August 2002

 Failure up to hyperinflation, inefficient government, economic performance  Old policies did not help the poor - inequality  New post 1991 policy regime delivered price stability and for a while faster growth and new confidence In 2002 it all went horribly wrong.  Three possible explanations: a) new consensus policies not fully applied (e.g. fiscal balance) b) new consensus policies provide wrong template (capital flows) c) policy mistakes (fixed exchange rate with dollar, loss of competitiveness), bad luck and inadequate response. ARGENTINA -- A CASE STUDY

As part of the objective of raising growth and reducing poverty, the IMF will continue to encourage African countries to pursue strong macroeconomic policies:  no one benefits from high inflation, particularly not the poor;  large budget deficits crowd out private investment and discourage exports;  and arrears [large public debt] deters investors. “ Raising Growth and Investment” Finance and Development December 2000 p. 33

and the Report continues ….  improve economic efficiency by liberalising trade and maintaining competitive exchange rates  remove the state from direct involvement in the production of marketable goods and services  enhance domestic competition in all sectors, especially agriculture  support regional integration efforts  improve infrastructure, particularly ports and communications  increase the share of government spending directed to education and health and improve the delivery of services in these areas  root out corruption and improve the quality and integrity of the legate system “Raising Growth and Investment” Finance and Development December 2000 p. 33