The 1980s and 1990s saw a market-led policy revolution in developing countries. This was the heyday of the “Washington Consensus”. But the climate for policy reform has worsened over the past decade. Strong economic growth in the last five years has bred reform complacency; and there is scepticism about the Washington Consensus. Reform fatigue has set in.
The sceptics are wrong. Especially in Asia, as countries that have liberalized and globalized strongly have grown faster and seen bigger increases in living standards for the broad majority than countries that have liberalized less or remained closed. Liberalization is far from complete: there remains much unfinished business in terms of taking down anti-competitive barriers. Tariffs in developing countries, averaging around 11%, are more than double of what they are in developed countries. Non-tariff trade barriers, and restrictions on foreign direct investment (FDI) and competition in services remain relatively high. Not least, domestic regulatory barriers that cramp domestic as well as foreign business are very high.
Such unfinished business leaves a very substantial reform agenda. But how to reform in conditions different from those of the 1980s and 1990s? What are the lessons of the past to guide future reforms?
First, comprehensive reforms have taken place mostly in response to a political or economic crisis. As Samuel Johnson said, “When a man knows he will be hanged in a fortnight, it concentrates the mind wonderfully.” Examples include Latin American countries in the late 1980s and early 1990s, eastern Europe and the ex-Soviet Union in the early 1990s, and India in 1991.
A crisis, however, does not guarantee sustainable market reforms. Complacency and fatigue tend to set in post-crisis. The problem is to roll out further reforms without a crisis to concentrate minds—as the Indian experience shows.
Second, organized minority interests always block reforms to protect their rents. Radical reforms, if they are sustained, usher in deep-seated changes to the economy, not least by expanding internationally tradable activities. Traditional protectionist interests are weakened. Countervailing interests—exporters, users of imported inputs, multinationals with global production networks, and cities and regions seeking to be magnets for trade and FDI—emerge. They have strong stakes in open trade. This reflects the Indian experience post-1991. The challenge is to harness these interests effectively to launch new reforms.
Third, ideas matter. As John Stuart Mill said “It is the word in season that does much to decide the result”. The Washington Consensus replaced an entrenched policy consensus in favour of state planning, import-substitution and foreign aid that prevailed in developing country governments and international organizations up to the 1970s. But now a climate of scepticism has set in. That bodes ill for further reforms. Now a coherent vision is needed of a liberal market economy and society and of the policies required to achieve it.
Fourth, institutions matter, too. These comprise the nature of the political system; the roles and interaction of the executive, legislature and judiciary; the legal system governing property rights and contracts; public agencies charged with economic regulation; and more generally, traditions and norms influencing the intersecting worlds of business, government and the law. This is the arena for policy choices and their implementation.
Institutional generalizations are notoriously difficult, but here are a few. Ministries of finance are prime movers of macro- and microeconomic reforms, usually in crisis conditions when they are most influential. However, post-crisis, they are less influential outside their core revenue-and-expenditure competencies; and that is when reform momentum wanes. Thus, it is vital to ensure a prominent role for finance ministries in future trade and related structural reforms.
More macroscopically, market reforms—particularly opening to the world economy—stimulate improvements in governance, regulation, the rule of law and infrastructure. The latter in turn buttress policy reforms and deliver better economic results. Turning to political systems, democracies usually find it more difficult than autocracies to charge forth with market reforms in the short-term. But, in the longer term, they are better at legitimizing and sustaining reforms.
Fifth, successful reforming countries have had home-baked reforms. Foreign aid and international organizations (such as the International Monetary Fund, the World Bank and the World Trade Organization) have, at best, been of second-line assistance and provided a “good housekeeping seal of approval”. Reforms have been much less successful when governments have relied less on unilateral measures and more on aid, donor “policy conditionality” and reciprocity in trade negotiations. These, then, are the lessons from the past 25 years of policy reforms. What are the future challenges?
About 20-25 “first-division” developing countries, with a population of about three billion, have already opened up significantly and are rapidly integrating into the global economy. They are overwhelmingly Asian, and include China and India. They have more to do on trade and FDI liberalization, but their bigger challenge is to shrink domestic regulatory barriers, reforms on which progress has been slow.
That leaves “lower-division” developing countries that are poorer, have reformed little and are less globalized. Their task is to go further with basic first-generation reforms. The dilemma is that countries at the bottom of this pile have failed and are failing states that cannot implement simple reforms.
Further market reforms are now more elusive than they were a decade ago. But they are the precondition for sustainable growth and better life chances for the broad mass of people. The stakes are still high, and a strong case for second generation reforms needs to be made.
Razeen Sally is director of the European Centre for International Political Economy in Brussels and on the faculty of the London School of Economics. Comment at email@example.com