Washington Consensus and trickle-down
Originally, the term Washington Consensus referred to ten main policy instruments on which Washington-based institutions like the IMF, the World Bank and the US Treasury agreed. These instruments included privatization, deregulation, trade liberalization and fiscal prudence.1 Latin American countries had to pursue them as a condition to qualify for financial aid from the US and the international institutions to overcome the debt crisis of the 1980s and 1990s. Nowadays, the same conditions are also applied to European countries like Greece to obtain financial support, but the term Washington Consensus is no longer very often used. It became a pejorative term around 2000, when the anti-globalization movement criticized the consensus as being neoliberal.
The idea behind these policy instruments was that economies would grow and wealth would trickle down from the rich to the poor. The theory was that, when economic growth took off, the rich would spend more on luxury goods, creating jobs for the non-rich. The non-rich would then have more to spend, which might create new jobs in for example the construction sector, as they could afford better housing. In this way, as long as there is economic growth, the wealth of the rich trickles slowly down to the non-rich and a middle class emerges.
The Kuznets curve and its critics
The economic theory supporting trickle-down is depicted by the Kuznets curve, which describes a pattern of increase and then decrease in inequality in a society. This model expresses an initial rise in inequality as industrialization sets in (implicating a widening rural-urban gap) and subsequent decline when the trickle-down effect starts having an impact and the welfare state starts to take shape. It is questionable, however, whether the Kuznets curve can support trickle-down on the basis of the Washington Consensus. In many of the countries where the Consensus was applied industrialization had already taken place. The Washington Consensus is not so much about industrialization, but about privatization, deregulation and creating a market economy.
Simon Kuznets based his model (first published in 1955) on a rather slim set of data, which all stemmed from the Western world: he took five observations for the US, five for the UK and two for Prussia, Saxony and United Germany.2 Kuznets himself was aware of this, stating “[t]he paper is perhaps 5 per cent empirical information and 95 per cent speculation.”3 Additionally, the empirical data do not always affirm the hypothesis. For example, Deiniger and Squire (World Bank) argue that much of the literature on the Kuznets hypothesis was politically motivated, fearing that the poor will suffer from development. However, on the base of longitudinal data, they find that ”many countries that started with low levels of per capita income grew rapidly without experiencing an increase in inequality, while countries that failed to grow were not immune against possibly considerable swings in aggregate measures of inequality.”4
LSE economist Noreena Hertz persuasively showed that in practice applying Washington Consensus policies does not lead to trickle-down.5 After the policies were applied in Latin America, growth percentages fell dramatically. After capitalism was introduced in Russia, inequality and poverty grew tremendously and life expectations dropped by 15 years in the 1990s.6 Economists argued that structural adjustment is needed to ensure growth on the long term, but as Keynes famously said, “in the long run we are all dead.”
As the overwhelming data in the reports by Oxfam and the OECD show, inequality is on the rise in the rich countries. The Kuznets curve is clearly not the end of the story.7 The Economist, for example, argues that the recent rise in inequality in advanced economies suggests an N-shape rather than an U-curve, which might indicate that the trickle-down effect has only limited effect. Moreover, since most of the poor tend to live in MICs these days, emerging economies deserve our special attention: in terms of policy, we should ask ourselves how increasing inequality in these rapidly growing economies should be addressed.
- Williamson, J. (1989) “What Washington Means by Policy Reform”, in: Williamson, J. (ed.): Latin American Readjustment: How Much has Happened, Washington: Institute for International Economics.
- Atkinson, A.B., and Brandoli, B. (2009): ‘On data: a case study of the evolution of income inequality across time and across countries’, Cambridge Journal of Economics 33, pp. 381 – 404, p. 383.
- Kuznets, S. (1955): ‘Economic growth and income inequality’, American Economic Review, vol. 45, 1–28, p. 26.
- Deininger, K. and Squire, L. (1998): ‘New ways of looking at old issues: inequality and growth’, Journal of Development Economics Vol. 57, 259–287, p. 261.
- Hertz, N. (2001), The Silent Takeover. Global Capitalism and the Death of Democracy, New York: The Free Press
- See also: Notzon, F.C. et al., “Causes of Declining Life Expectancy in Russia”, JAMA March 11, 1998, Vol 279, No. 10. Stuckler, D. et al., “Mass privatisation and the post-communist mortality crisis: a cross-national analysis”, in: The Lancet, Volume 373, Issue 9661, 31 January–6 February 2009, Pages 399-407.
- Also see Milanovic, B. (2011), ‘More or Less’, Finance & Development, 48( 3).