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The innocuous doctrine that shapes boom and bust

David Lubin sets out his vision for emerging economies

By Will Grahame-Clarke 20 December 2018

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Developing nations suffered financial crises for decades because of America’s free-market ‘fetishism’, according to economist and author David Lubin.

Lubin, Head of Emerging Market Economics at Citi was invited by the Wheeler Institute for Business and Development to discuss his new book Dance of the Trillions: Developing Countries and Global Finance. The book explores the destabilising effects of unrestricted capital flows to the developing world.

The US wields its influence through a neoliberal consensus on free-market principles, argues Lubin. The conceptual heart of the book is the Washington Consensus, which, according to Lubin, is a “shorthand for neoliberalism and for the idea that the market should be given an unrestricted capacity to allocate resources throughout the economy.”


The Washington Consensus

The Washington Consensus is a policy framework developed by British economist John Williamson. He coined the phrase in his 1989 book Latin American Adjustment: How Much Has Happened?

The Consensus consisted of 10 policies aimed at giving developing countries’ policymakers the means, if they wished, to plug their economy into a newly globalising international economy. 

“The Consensus was an obsession, almost a fetish of the US Treasury and the IMF.”

The policies included keeping budget deficits relatively low; letting markets decide interest rates; protecting property rights; spending public money wisely and encouraging the inflow of foreign direct investment. The consensus also advocated liberalising trade, reducing tariffs and opening the economy up to trade, de-regulating and removing the state from activities deemed unnecessary “Nothing by modern standards that was too controversial,” says Lubin.

However, the Consensus had a ‘second life’, which Williamson himself unsuccessfully railed against. “The Consensus was an obsession, almost a fetish of the US Treasury and the International Monetary Fund (IMF),” says Lubin. “The idea was taking that kind of neoliberal idea that the market should be given an overriding capacity to allocate capital across the economy.”

Williamson argued that the only form of capital developing countries should allow in was foreign direct investment. He believed that all other forms of capital flow should be at the discretion of developing countries’ policymakers to impose capital controls, to use taxes, to use regulatory measures to restrict easily reversible capital flows. That is the key point of the debate.

“The Americans were bitterly opposed,” says Lubin, quoting the memoirs of a contemporary observer, “because it would have meant interfering with the freedom of financial markets and the freedom of American commercial banks, to make enormous profits out of lending to the Third World.”

“The way developing countries should manage their capital accounts, according to the US government, was to let the market decide.”

“This idea that the market should be given this unrestricted capacity to allocate capital internationally was sewn into the fabric of the international financial system very early on, and it was sewn in by the US government.”

“At the time, the US government converted its economic power into intellectual influence. It converted its economic way into the global economy into a set of ideas about the way developing countries should manage their capital accounts. The way developing countries should manage their capital accounts, according to the US government, was to let the market decide.”

Boom and bust

Lubin acknowledges the irony of this policy was that US monetary policy should be the greatest influence on volatility of capital movements. When monetary conditions are very loose in the US that tends to push capital towards emerging economies, because investors are looking for higher returns. When monetary conditions in the US tighten, that tends to suck capital back to the US, creating financing crises.

Hélène Rey, Lord Bagri Professor of Economics at London Business School, says these financial flows have been responsible for all emerging market crises as well as the 2008 crisis. Professor Rey argues there are three options to tame the cycle: capital flow management, macro prudential authorities or to reach international agreement for monetary and exchange rate management, like the post-war agreement at Bretton-Woods in 1944.

“On the issue of reforming the international monetary system, I think the reality is that that's not going to happen soon,” says Lubin. “A proper renegotiation of the international monetary system that would involve some redistribution of international monetary power is not going to happen until there all sorts of other types of power are redistributed.”

“I think that capital control, capital flow measures and macro-prudential tools will help.”

China’s future role

In the final chapter Toward a Beijing Consensus Lubin argues that China will play a much bigger role in global finance, but not in the immediate future.

“There is a huge gap between China’s impact on the real economy and on the financial system,” observes Professor Rey.

Lubin says of his vision: “I was very nervous writing that last chapter because I realised that I was expressing a view about not the next thing to happen, but maybe the next after the next after the next things to happen. The interim is very, very unclear.”

According to Lubin, China remains a minnow in international finance, and will remain so “for a long time” because of the capital controls it has in place. Those controls prevent its wealth from diversifying out of China and out of renminbi, which itself is not strong enough to replace the dollar as an international trade currency. Even China’s Belt and Road infrastructure scheme has been largely financed in dollars.

Despite these caveats, Lubin predicts China will eventually extend its influence on trade to include rewriting the global financial rules for emerging economies.

David Lubin, Head of Emerging Market Economics at Citi, was in discussion with Hélène Rey, Lord Bagri Professor of Economics at London Business School and Elias Papaioannou, Professor of Economics and Academic Director, Wheeler Institute for Business and Development.  Established through the support of Lonely Planet Founders Tony and Maureen Wheeler, the Wheeler Institute aims to illuminate and help solve the world’s most pressing global development issues through sharing and applying business expertise.

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