The End of the Washington Consensus
by Michael Hudson and Jeffrey
Wall Street's financial meltdown marks
the end of an era. What has ended is the credibility of the Washington
Consensus - open markets to foreign investors and tight money
austerity programs (high interest rates and credit cutbacks) to
"cure" balance-of-payments deficits, domestic budget
deficits and price inflation. On the negative side, this model
has failed to produce the prosperity it promises. Raising interest
rates and dismantling protective tariffs and subsidies worsen
rather than help the trade and payments balance, aggravate rather
than reduce domestic budget deficits, and raise prices. The reason?
Interest is a cost of doing business while foreign trade dependency
and currency depreciation raise import prices.
But even more striking is the positive
side of what can be done as an alternative to the Washington Consensus.
The $700 billion U.S. Treasury bailout of Wall Street's bad loans
on October 3 shows that the United States has no intention of
applying this model to its own economy. Austerity and "fiscal
responsibility" are for other countries. America acts ruthlessly
in its own economic interest at any given moment of time. It freely
spends more than it earns, flooding the global economy with what
has now risen to $4 trillion in U.S. government debt to foreign
This amount is unpayable, given the chronic
U.S. trade deficit and overseas military spending. But it does
pose an interesting problem: why can't other countries do the
same thing? Is today's policy asymmetry a fact of nature, or is
it merely voluntary and the result of ignorance (spurred by an
intensive globalist ideological propaganda program, to be sure)?
Does India, for instance, need to privatize its state-owned banks
as earlier was planned, or is it right to pull back? More to the
point, have the neoliberal programs imposed on the former Soviet
Union succeeded in "Americanizing" their economies and
raising production capacity and living standards as promised?
Or, was it all a dream, indeed, a nightmare?
The three Baltic countries, for instance
- Latvia, Estonia and Lithuania - have long been praised in the
Western press as great success stories. The World Bank classifies
them among the most "business friendly" countries, and
their real estate prices have soared, fueled by foreign-currency
mortgages from neighboring Scandinavian banks. Their industry
has been dismantled, their agriculture is in ruins, their male
population below the age of 35 is emigrating. But real estate
prices added to the net worth on their national balance sheets
for nearly a decade. Has a new "moment of truth" arrived?
Just because the Soviet economic system culminated in bureaucratic
kleptocracy, has the neoliberal model really been so much better?
Most important of all, was there a better alternative all along?
We expect the post-Soviet economies to
go the way of Iceland, having taken on foreign debt with no visible
means of paying it off via exports (the same situation in which
the United States finds itself), or even further asset sales.
Emigrants' remittances are becoming a mainstay of their balance
of payments, reflecting their economic shrinkage at the hands
of neoliberal "reformers" and the free-market international
dependency that the Washington Consensus promotes. So, just as
this crisis has led the U.S. government to shift gears, is it
time for foreign countries to seek to become more in the character
of "mixed economies"? This has been the route taken
by every successful economy in history, after all. Total private-sector
markets (in practice, markets run by the banks and money managers)
have shown themselves to be just as destructive, wasteful and
corrupt and, indeed, centrally planned as those of totally "statist"
governments from Stalin's Russia to Hitler's Germany. Is the political
pendulum about to swing back more toward a better public-private
Washington's idealized picture of how
free markets operate (as if such a thing ever existed) promised
that countries outside the United States would get rich faster,
approaching U.S.-style living standards if they let global investors
buy their key industries and basic infrastructure. For half a
century, this neoliberal model has been a hypocritical exercise
in poor policy at best, and deception at worst, to convince other
economies to impose self-destructive financial and tax policies,
enabling U.S. investors to swoop in and buy their key assets at
distress prices. (And for the U.S. economy to pay for these investment
outflows in the form of more and more U.S. Treasury IOUs, yielding
a low or even negative return when denominated in hard currencies.)
The neoliberal global system never was
open in practice. America never imposed on itself the kind of
shock therapy that President Clinton's Treasury Secretary (and
now Obama's advisor) Robert Rubin promoted in Russia and the rest
of the former Soviet bloc, from the Baltic countries in the northwest
to Central Asia in the southeast. Just the opposite! Despite the
fact that America's own balance of trade and payments is soaring,
consumer prices are rising and financial and property markets
are plunging, there are no calls among its power elite to let
the system self-correct. The Treasury is subsidizing America's
financial markets so as to save its financial class (minus some
sacrificial lambs) and support its asset prices. Interest rates
are being lowered to re-inflate asset prices, not raised to stabilize
the dollar or slow domestic price inflation.
The policy implications go far beyond
the United States itself. If the United States can create so much
credit so quickly and so freely - and if Europe can follow suit,
as it has done in recent days - why can't all countries do this?
Why can't they get rich by following that path that the United
States actually has taken, rather than merely doing what its economic
diplomats tell them to do with sweet self-serving rhetoric? U.S.
experience itself provides the major reason why the free market,
run by financial institutions allocating credit, is a myth, a
false map of reality to substitute for actual gunboats in getting
other countries to open their asset markets to U.S. investors
and food markets to U.S. farmers.
By contrast, the financial and trade model
that U.S. oligarchs and their allies are promoting is a double
standard. Most notoriously, when the 1997 Asian financial crisis
broke out, the IMF demanded that foreign governments sell out
their banks and industry at fire-sale prices to foreigners. U.S.
vulture capital firms were especially aggressive in grabbing Asian
and other global assets. But the U.S. financial bailout stands
in sharp contrast to what Washington Consensus institutions imposed
on other countries. There is no intention of letting foreign investors
buy into the commanding U.S. heights, except at exorbitant prices.
And for industry, the United States has once more violated international
trade rules by offering special bailout money and subsidies to
its own Big Three U.S. automakers (General Motors, Ford and Chrysler)
but not to foreign-owned automakers in the United States. In thus
favoring its own national industry and taking punitive measures
to injure foreign-owned investments, the United States is once
again providing an object lesson in nationalistic economic policy.
Most important, the U.S. bailout provides
a model that is far preferable to the Washington Consensus-for-export.
It shows that countries do not need to borrow credit from foreign
banks at all. The government could have created its own money
and credit system rather than leaving foreign creditors to accrue
interest charges that now represent a permanent and seemingly
irreversible balance-of-payments drain. The United States has
shown that any country can monetize its own credit, at least domestic
credit. A large part of the problem for Third World and post-Soviet
economies is that they never experienced the successful model
of managerial capitalism that predated the neoliberal model, advocated
since the 1980s by Washington.
The managerial model of capitalism, predominating
during the post-World War II period until the 1980s (with antecedents
in 18th-century British mercantilism and 19th-century American
protectionism), delivered high growth. Postwar planners, such
as John Maynard Keynes in England and Harry Dexter White in the
United States, favored production over finance. As Winston Churchill
quipped, "nations typically do the right thing [pause], after
exhausting all other options." But it took two world wars,
interspersed by an economic depression triggered by debts in excess
of the ability to pay, to give the final nudge required to promote
manufacturing over finance and finally do "the right thing."
Finance was made subordinate to industrial
development and full employment. When this economic philosophy
reached its peak in the early 1960s, the financial sector accounted
for only 2 per cent of U.S. corporate profits. Today, it is 40
per cent! Carrying charges on America's exponentially growing
debt are diverting income away from purchasing goods and services
to pay creditors, who use the money mainly to lend out afresh
to borrowers to bid up real estate prices and stock prices. Tangible
capital investment is financed almost entirely out of retained
corporate earnings - and these too are being diverted to pay interest
on soaring industrial debt. The result is debt deflation - a shrinkage
of spending power as the economic surplus is "financialized,"
a new word, only recently added to the world's economic vocabulary.
Since the 1980s, the U.S. tax system has
promoted rent seeking and speculation on credit to ride the wave
of asset-price inflation. This strategy increased balance sheets
as long as asset prices rose faster than debts (that is, until
last year). But it did not add to industrial capacity. And meanwhile,
tax cuts caused the national debt to soar, prompting U.S. Vice
President Dick Cheney to comment, "Reagan proved deficits
On the international front, the larger
the U.S. trade and payments deficit, the more dollars were pumped
into foreign hands. Their central banks recycled them back to
the U.S. economy in the form of purchases of Treasury bonds and,
when the interest rates fell almost to zero, securitized mortgage
packages. Current Treasury Secretary Henry Paulson assured Chinese
and other foreign investors that the government would stand behind
Fannie Mae and Freddie Mac as privatized mortgage-packaging agencies,
guaranteeing a $5.2 trillion supply of mortgages. This matched
in size the U.S. public debt in private hands.
Meanwhile, the Treasury cut special deals
with the Saudis to recycle their oil revenues into investments
in Citibank and other U.S. financial institutions - investments,
on which they have lost many tens of billions of dollars. To cap
matters, pricing world oil in dollars kept the U.S. currency stronger
than underlying economic fundamentals justified. The U.S. economy
paid for its imports with government debt never intended to be
repaid, even if it could be (which it can't at today's $4 trillion
level, cited earlier). The American economy, thus, has seen its
trade deficit and asset prices rise in accordance with economic
laws that no other nation can emulate, topped by the ability to
run freely into international debt without limit.
Managerial capitalism mobilized rising
corporate net worth and equity value to build up in the real economy.
But since the 1980s, a new breed of financial managers has pledged
assets as collateral for new loans to buy back corporate stock
and even to pay out as dividends. This has pushed up corporate
stock prices and, with them, the value of stock options that corporate
managers give themselves. But it has not spurred tangible capital
A real estate bubble in all countries
has been fueled by rising mortgage debt. To buy a new home, buyers
must take on a lifetime of debt. This has made many employees
afraid to go on strike or even to press for better working conditions,
because they are "one check away from homelessness,"
or mortgage foreclosure. Meanwhile, companies have been outsourcing
and downsizing their labor force, eliminating benefits, imposing
longer hours, and bringing more women and children into the workforce.
Today's "new economy" is based
not on new technology and capital investment, as former Fed chairman
Alan Greenspan trumpeted in the late 1990s, but on price inflation
generating capital gains (mainly in land prices, as land is still
the largest asset in the U.S. and other industrial economies).
The economic surplus is absorbed by debt service payments (and
higher priced health care), not investment in production or in
sharing productivity gains with labor and professionals. Wages
and living standards are stagnant for most people, as the economy
tries to get rich by "the miracle of compound interest,"
while capital gains emanating from the financial sector provide
a foundation for new credit to bid up asset prices, all the more
in a seemingly perpetual motion credit-and-debt machine. But the
effect has been for the richest 1 per cent of the population to
increase its share of interest extraction, dividends and capital
gains from 37 per cent ten years ago to 57 per cent five years
ago, and nearly 70 per cent today. Savings remain high, but only
the wealthiest 10 per cent are saving - and this money is being
lent out to the bottom 90 per cent, so no net saving is occurring.
Internationally, too, the global economy
has polarized rather than converged. Just as independence arrived
for many Third World countries only after their former European
colonial powers had put in place inequitable land tenure patterns
(latifundia, owned by domestic oligarchies) and export-oriented
production, so independence for the post-Soviet countries from
Russia arrived after managerial capitalism had given way to a
neoliberal model that viewed "wealth creation" simply
as rising prices for real estate, stocks and bonds. Western advisors
and former emigrants descended to convince these countries to
play the same game that other countries were playing - except
that real estate debt for many of these countries was denominated
in foreign currency, as no domestic banking tradition had been
developed. This became increasingly dangerous for economies that
did not put in place sufficient export capacity to cover the price
of imports and the mounting volume of foreign-currency debt attached
to their real estate. And nearly all the post-Soviet countries
ran structural trade deficit, as production patterns were disrupted
with the breakup of the U.S.S.R.
Real estate and capital gains from asset-price
inflation (not industrial capital formation) were promoted as
the way to future prosperity in countries whose profits from manufacturing
were low and wages were stagnant. The problem is this alchemy
is not sustainable. An illusion of success could be maintained
as long as Washington was flooding the globe with cheap money.
This led Swedes and other Europeans to find capital gains by extending
loans to feed neighboring countries from Iceland to Latvia, above
all via their real estate markets. For some exporters (especially
Russia), rising oil and metal export prices became the basis for
capital outflows into Third World and post-Soviet financial markets.
Some of the backwash, for example, flowed into the world's burgeoning
offshore banking and real estate sectors - only to stop abruptly
when the real estate bubble burst. __In these circumstances, what
is to be done? First, countries outside the United States need
to recognize how dysfunctional the neoliberalized world economy
has been made, and to decide which assumptions underlying the
neoliberal model must be discarded. Its preferred tax and financial
policies favor finance over industry and, hence, financial maneuvering
and asset-price inflation over tangible capital formation. Its
anti-labor austerity policies and un-taxing of real estate, stocks
and bonds divert resources away from growth and rising living
Likewise destructive are compound interest
and capital gains over the long term. The real economy can grow
only a few per cent a year at best. Therefore, it is mathematically
impossible for compound interest to continue unabated and for
capital gains to grow well in excess of the underlying rate of
economic growth. Historically, economic crises wipe out these
gains when they outpace real economic growth by too far a margin.
The moral is that compound interest and hopes for capital gains
cannot guarantee income for its retirees or continue attracting
foreign capital. Over a period of a lifetime, financial investments
may not deliver significant gains. For the United States, it took
markets about twenty-five years, from 1929 to the mid-1950s, to
recover their previous value.
Today's desperate U.S. attempt to re-inflate
post-crash prices cannot cure the bad-debt problem. Foreign attempts
to do this will merely aid foreign bankers and financial investors,
not the domestic economy. Countries need to invest in their real
economy, to raise productivity and wages. Governments must punish
speculation and capital gains that merely reflect asset-price
inflation, not real value. Otherwise, the real economy's productive
powers and living standards will be impaired and, in the neoliberal
model, loaded down with debt. Policies should encourage enterprise,
not speculation. Investment seeks growing markets, which tend
to be thwarted by macroeconomic targets such as low inflation
and balanced budgets. We are not arguing that inflation and deficits
can be ignored, but rather that inflation and deficits are not
all created equally. Some variants hurt the economy, while others
reflect healthy investment in real production. Distinguishing
between the two effects is vital, if economies are to move forward
to achieve self-dependency.
In sum, a much better economy can be created
by rejecting Washington's financial model of austerity programs,
privatization selloffs and trade dependency, financed by foreign-currency
credit. Prosperity cannot be achieved by creating a favorable
climate for extractive foreign capital, or by tightening credit
and balancing budgets, decade after decade. The United States
itself has always rejected these policies, and foreign countries
also must do this if they wish to follow the policies, by which
America actually grew rich, not by what U.S. neoliberal advisors
tell other countries to do to please U.S. banks and foreign investors.
Also to be rejected is the anti-labor
neoliberal tax policy (heavy taxes on employees and employers,
low or zero taxes on real estate, finance and capital gains) and
anti-labor workplace policies, ranging from safety protection
and health care to working conditions. The U.S. economy rose to
dominance as a result of Progressive Era regulatory reforms prior
to World War I, reinforced by popular New Deal reforms put in
place in the Great Depression. Neoliberal economics was promoted
as a means of undoing these reforms. By undoing them, the Washington
Consensus would deny to foreign countries the development strategy
that has best succeeded in creating thriving domestic markets,
rising productivity, capital formation and living standards. The
effect has been to decouple saving from tangible capital formation.
They need to be re-coupled, and this can be achieved only by restoring
the kind of mixed economy by which North America and Europe achieved
their economic growth.__
Michael Hudson is professor of Economics
at the University of Missouri (Kansas City) and chief economic
advisor to Rep. Dennis Kucinich. He has advised the U.S., Canadian,
Mexican and Latvian governments, as well as the United Nations
Institute for Training and Research (UNITAR). He is the author
of many books, including Super Imperialism: The Economic Strategy
of American Empire (new ed., Pluto Press, 2002). He can be reached
via his website, firstname.lastname@example.org.
Jeffrey Sommers is a professor at Raritan
Valley College, NJ, visiting professor at the Stockholm School
of Economics in Riga, former Fulbrighter to Latvia, and fellow
at Boris Kagarlitsky's Institute for Global Studies in Moscow.
He can be reached at email@example.com.