Foreign Policy In Focus Special Report: U.S. Leadership in the Global Economy - The New Majority to Slow Down and Reshape Globalization

In the last two years, the debate over U.S. policy toward the global economy has expanded from an almost exclusive focus on trade and investment policy to increasing concerns about short-term finance. As the recent global financial crisis spread, the longstanding elite argument that free markets lead to development began unraveling.

Free trade and investment policies have spawned an effective citizen backlash in both North and South since the early 1990s.

At the onset of a new century, the Washington Consensus is now severely discredited and threatened by two dynamics. First, free trade and investment policies have generated widespread human suffering and environmental degradation, which, in turn, have spawned an increasingly effective citizen backlash in both Northern and Southern nations since the early 1990s. Second, deregulated finance flows have engendered extreme volatility in the financial markets of numerous developing and newly industrialized nations--such as Indonesia and South Korea--and have precipitated severe economic downturns.

Although outside criticism of the elite consensus has been growing throughout the 1990s, the consensus among governments, economists, and multilateral institutions held quite firm until the Asian financial crisis spread globally in 1998.¹⁴ The roots of the crisis lie in the World Bank, the IMF, and the U.S. Treasury pressuring governments around the globe during the 1990s to open their stock markets and financial markets to short-term investments from the West. Quick injections of capital from mutual funds, pension funds, and other sources did propel growth in the 1990s, but they also encouraged bad lending and bad investing. Between 1990 and 1996, the volume of private financial flows entering poorer nations skyrocketed from $44 billion/year to $244 billion.¹⁵ Roughly half of this was long-term direct investment, but most of the rest was footloose, moving from country to country at the tap of a computer keyboard.

When Western investors got spooked in Thailand, Indonesia, and several other countries in mid-1997, the "hot money" panicked and left much faster than it had arrived. Big-time currency speculators deepened the crisis by betting against the currencies of the crisis nations. Currencies and stock markets from Korea to Brazil nose-dived, and as these nations stopped buying everything from oil to wheat, prices of these products plummeted as well. As the financial crises have spread from foreign exchange accounts at central banks to the industrial centers of the Indonesian, Russian, and other affected countries, there has been widespread pain, dislocation, death, and environmental ruin. The International Confederation of Free Trade Unions predicted that more than 27 million people would be unemployed in the five worst-hit Asian nations (Philippines, Indonesia, Malaysia, Thailand, and Korea) by the end of 1999.¹⁶

Figure 4

U.S. Public Rejects Trade

1 Bad for U.S. economy because cheap imports hurt wages and jobs.
2 Good for U.S. economy; creates foreign demand, U.S. economic growth, and jobs.

Source: Wall Street Journal/NBC News poll published in the Wall Street Journal, December 10, 1998.

Fiddling while Asia burns, U.S. Treasury Secretary Larry Summers--continuing his predecessor Robert Rubin’s approach--proclaims the lofty rhetoric of constructing "a new global financial architecture" while continuing to advocate mere cosmetic changes, like increasing information disclosure and flow among nations. Yet, since real economies have collapsed, two sets of elite actors have broken away from the status quo positions of the IMF and the U.S. Treasury Department.

One faction supports free markets for trade, but not with respect to short-term capital. This group is led by such prestigious free-trade economists as Jagdish Bhagwati of Columbia University, Paul Krugman of MIT, Jeffrey Sachs of Harvard, and World Bank chief economist Joseph Stiglitz. Bhagwati argues that capital markets are by their nature unstable and require controls. Krugman has outlined the case for exchange controls as a response to crisis. Henry Kissinger, with his focus on promoting long-term over speculative investment, also falls within this group.¹⁷ As dramatic as some of these proposals are and as heated as the debate may sound, overall the group largely seeks to restore the consensus by allowing national exchange and/or capital controls under certain circumstances.

Not surprisingly, these critics also tend to disagree with portions of IMF structural adjustment programs. Prominent economists such as Jeffrey Sachs, one of the architects of the U.S.-promoted economic restructuring in Russia, have faulted the IMF for recessionary policies in Asia that turned a liquidity crisis into a financial panic and triggered economic collapse in a growing list of nations. They press for a major revision of IMF policies in favor of openness and creating more space for different policy responses to meet the needs of the moment.

The other set of dissidents argues for the abolition of the IMF. They view the problem as IMF interference in markets by bailing out investors, an activity that eliminates the discipline of risk in private markets (a phenomenon this faction calls "moral hazard"). This camp is led by such long-time free trade institutions as the Heritage Foundation and the Cato Institute (whose concern about publicly funded aid institutions in nothing new) as well as some free market economists, like Milton Friedman of the University of Chicago. The group’s ranks have recently swelled with such well-known and vocal converts as Citibank’s Walter Wriston, former Secretary of State George Shultz, and former Treasury Secretary William E. Simon.¹⁸

These two main offshoots of dissent within the consensus have been bolstered by new center-left governments in many European countries, who are also raising their voices to question parts of the consensus. For example, the French government helped stall efforts to further liberalize investment flows. Voices in the Canadian parliament (with counterparts in Europe) are exploring an international tax on foreign currency transactions to discourage the overwhelming majority of transactions, whose intent is purely speculative. Most Western European governments support at least limited versions of capital controls, and many press for explicit management of exchange rates.

Most of these elite dissenters share a strategic goal: to salvage the overall free market thrust of the Washington Consensus by modifying earlier positions in favor of unregulated capital flows. And although the debate is heated between these groups and the IMF/Treasury pillar, the arguments are largely over revisions to the consensus.

Still, the language some use in their critiques is raising questions about the wisdom of the theoretical foundations of the Washington Consensus and about the narrow interests that it serves. Free trade champion Bhagwati--echoing President Eisenhower, who warned of the military-industrial complex--has decried free capital mobility across borders as the work of the "Wall Street-Treasury complex." By this he means the powerful men who move from Wall Street financial firms to the highest echelons of U.S. government and back, and who, in Bhagwati’s words, form a clique that is "unable to look much beyond the interest of Wall Street, which it equates with the good of the world."¹⁹

The Washington Consensus faces attack from the same groups that led the opposition to its free trade agenda, as anti-free trade coalitions of all political stripes have expanded their critiques to encompass financial flows.

In addition to these internal critics, however, the Washington Consensus faces continued attack from the same groups that led the opposition to its free trade agenda, as anti-free trade coalitions of all political stripes have expanded their critiques to encompass financial flows. These groups point out that the financial crisis has exacerbated the social and environmental crises endemic to the elite consensus.

On the environmental front, the more progressive critics are sounding the alarm that among the nations worst hit by the financial contagion are four of the six "emerging market" countries with the largest remaining tracts of forest: Brazil, Russia, Indonesia, and Mexico. With their economies now deeply integrated into the international market, all four feel pressure to increase their foreign exchange reserves by exporting timber resources. In 1998, this author witnessed first hand the environmental effects of the crisis in the Philippines; the pressure to increase export earnings prompted the government to rush through a series of investment projects that threaten vast environmental damage. These and related concerns helped propel elements of the progressive coalition in at least 15 countries to obstruct the elite consensus attempt to standardize liberalized foreign investment rules across the globe in the proposed "Multilateral Agreement on Investment."

On the economic front, although the opposition of the political right and left to the corporate-driven global economy arises from different visions of alternatives to the Washington Consensus, the two strange bedfellows have, on key occasions, joined forces to block further momentum of the free trade agenda. Evidence of the success of this joint tactical alliance is seen in the congressional defeats of "fast track" trade authority and in public opinion polls revealing that the U.S. public is opposed to fast track and NAFTA by roughly a two-to-one margin.

In addition to the acrimonious public debate over free trade, citizen groups in both the North and South have exposed the adverse development impacts of the World Bank and the IMF, the two institutions that most zealously enforce Washington Consensus policies. After two decades of prodding the World Bank to address the impact of its policies on the environment, women, the poor, and workers, several hundred nongovernmental groups convinced World Bank President James Wolfensohn to carry out a multicountry comprehensive review of the bank’s policies. Labeled the Structural Adjustment Policy Review Initiative (SAPRI), the effort has helped to document the abuses of the structural adjustment, free market model.²⁰