Collapse of Market Fundamentalism
Stiglitz is Right, Friedman is Wrong
Council on Hemispheric Affairs (September 04 2008)
Among the throng of distinguished international guests participating in the first democratic transition of government in Paraguay's 190-year history, former chief World Bank economist and current Columbia Professor of economics Joseph Stiglitz (who also was an advisor to the Clinton White House) was undoubtedly the most influential. Two days before left-leaning president-elect Fernando Lugo's inauguration, Stiglitz's lecture on globalization and equitable growth drew a full house to the "Grand Theater" of Paraguay's central bank. Elites of various stripes filled the auditorium's plush seats, as the country's largest soy estate farmers, ranchers, industrialists, business leaders, and civil-society leaders showed up for a glimpse of what the new government's economic and social policy might look like.
Notwithstanding the persistence of international media prophecies that Hugo Chavez's economic game plan for Venezuela would be duplicated in Asuncion, President Lugo has given plenty of indication that he aims to provide pragmatic leadership. One tip-off to this is his naming of US-educated macro-economist Dionisio Borda as Minister of Finance. Broadly respected and considered highly competent, Borda occupied the same post for two years in the outgoing government, where he headed a successful effort to balance public finances and achieve macroeconomic stability before resigning in protest over the failure of the prior Duarte administration to introduce more structural reforms of the public bureaucracy. Borda has emerged once again as the central figure of the team named by newly inaugurated President Fernando Lugo to execute his expressed goals of public-sector reform, equitable growth, and environmental sustainability. However, despite all attempts to distance himself from South America's more muscular left, Lugo - like Brazilian president Lula on the eve of his inauguration - must weather the local elite's deep apprehension over a government that counts among its mandates a directive to reduce the country's grave social and economic inequalities.
In this context, advice coming from such a well respected figure as Stiglitz represents a valuable tool for beating into plowshares the ideological weapons wielded by the interests that sustained sixty-plus years of extremely corrupt and cruel Colorado Party-rule. It must have been alarming for certain members of the audience to hear Stiglitz gloriously debunk, one by one, the conservative positions which development authorities and international institutions formerly embraced to bolster their positions and to which local elite groups and much of the media still cling. With great authority and occasional cheek, Stiglitz enumerated the flaws and misconceptions that have characterized the past decade of broken development thinking. He openly declared that bilateral free-trade agreements almost inevitably favor the US and offer few advantages for poorer, agricultural economies such as Paraguay's; that 'trickle-down' economics does not work and has never worked; that land reform was the basis of successful development experiences in East Asia; that privatization is not an automatic or necessarily the best answer to the woes of publicly-owned enterprises; that US monetary policy, rather than Latin American industrial policy, was to blame for the region's 'lost decade' in the 1980s; and that public investment forms the basis for private dynamism in developing countries as much as it does in developed countries like the US. Stiglitz summarized his position by pointing toward the current US mortgage crisis, stating that markets alone produce neither efficient nor socially desirable outcomes. Instead, he insisted that dogmatic faith in markets provokes periodic crises that erase the gains achieved through growth and which hit the poor the hardest.
Stiglitz's assertions are a far cry from the advice Paraguay's new leaders would have received had they stood at this juncture a short number of years ago. In 1989, the year the country became nominally democratic, Latin America's economic policy was still dominated by the so-called "Chicago Boys". After Latin American PhD candidate economists would study with Milton Friedman and his colleagues at the University of Chicago, they predictably would return home to engineer the economic recovery of a Mexico in the 1980s, whose economy was under the control of the quasi-authoritarian PRI regime, or General Pinochet's military Junta in Chile, allegedly rescuing these repressive regimes from the severe economic dislocations and stagnation which they were then facing. According to the thinking of the day, excessive government involvement in the economy was to blame for the region's economic woes.
Developing countries, they maintained, must create suitable conditions for private investment to generate growth by crafting a good business environment through the liberalization of trade and finance, privatization of state-owned enterprise and public utilities, and maintenance of low inflation rates. This resurrection of the classical or 'liberal' economic theory formed the basis of the "Washington Consensus" of the 1990s, among the US-based and influenced international development and multilateral lending institutions, such as the International Monetary Fund, the World Bank, and the Inter-American Development Bank. The reigning doctrine of these institutions was that the governments of developing countries ought to focus on fundamentals such as maintaining macroeconomic stability while generally shrinking the size of the public sector. In practice, this often meant that government curtailed or abandoned its social obligations in order to maintain a good budget profile; meanwhile, trade liberalization and unregulated financial flows were leaving vulnerable citizens exposed to the vagaries of the global economy. Thus, rather than witnessing market-led development, neoliberal economic restructuring has triggered a wave of leftist electoral triumphs around Latin America, as voters responded with frustration to a decade of mediocre growth and the stagnation or outright deterioration of social conditions.
After several decades during which free-market fundamentalism dominated development theory and policy, Stiglitz's visit to Paraguay and the content of his advice demonstrated an important political and ideological shift. Aside from his positive influence on a younger generation of economists at the international lending agencies, Stiglitz is one of a number of economists whose ideas appear to be forming the foundation for a 'post-Washington Consensus' mentality. Stiglitz received his PhD in economics from the Massachusetts Institute of Technology and, after his departure from there, continued to steep himself in an intellectual tradition with altogether different implications for the proper role of government in the economy than was the provenance offered by the Chicago School. The scholar went on to win the Nobel Prize in economics in 2001 for his work showing that markets fail to produce efficient outcomes whenever economic actors do not act on perfect information. This is a condition that is nearly universally true and that invites, if not requires, a wide set of government interventions into the market and an aggressive regulation of the private sector aimed at enhancing efficiency. Consequently, Stiglitz argues that the reason that Adam Smith's "invisible hand" seems so invisible is because it is often not there to guide self-interested behavior in the direction of socially beneficial outcomes. Moreover, addressing his audience of elite Paraguayans, Stiglitz argued that, even with proper regulation, markets do not necessarily produce socially equitable outcomes and cannot alone effectively address entrenched inequalities in developing countries such as Paraguay. He thus opened wide the door toward social policy and redistributive spending that earlier development thinking had closed off as unnecessary, if not distortive, or at least counterproductive and vulgar.
Stiglitz expressed his optimism that Paraguay would be wise to seek an alternative path to demonstrate what an alternative 'post-Washington Consensus' would look like and how it could work. Some the features described by Stiglitz as part of this alternative sound exciting, in particular, helping Paraguay to join the global economy by investing in the knowledge economy, closing the technology gap, and establishing programmatic research projects at the country's universities. However, other reforms described by Stiglitz as crucial for meeting the challenges of equitable growth most likely sounded harsher to his audience. First, Paraguay must expand its tax base if it is to make the public investments necessary for growth, competitiveness, and equity in today's economy. Paraguay remains something of an anomaly, Stiglitz argued, with no income tax and a total tax burden of only eleven percent of GDP (the lowest in the region). Even if the strategy now in use curbs tax evasion and improves the efficiency of public spending, the new government will need far more resources than are currently available for investments in infrastructure and education.
When asked where and how such taxes could be effectively applied, given the country's insufficient administrative capacity, Stiglitz implicitly suggested that some of those in his audience should foot the bill. Taxing the country's beef and soybean exports, he proposed, would generate fewer administrative costs, as the products must pass through a limited number of ports. Stiglitz refused to spare Paraguay's rural elites of being at least partially responsible for the country's social problems, maintaining that, as the country's main engines of growth, the ranching and soybean industries have neither generated enough employment nor driven away inequality. Accordingly, Stiglitz cited agrarian reform as another necessary step for Paraguay, which is among the countries with the highest levels of land concentration in the world. He emphasized that land reform was what built the foundation for the successful development experiences in East Asia, and that making land and other productive resources available to the poor would enhance both economic growth and equality. Finally, Stiglitz stressed the need for thorough civil service reform to properly staff the public sector with qualified professionals, hired through competitive exams and employed without tenure. This means dismantling the suffocating patronage system that allowed the Colorado party to hold power for more than sixty years and which guaranteed Paraguay's elites the support of an urban middle class largely dependent on clientelistic access to public-sector employment, as a mainstay of the available job market.
Stiglitz's diagnosis of Paraguay's economic and social problems and his prescribed reforms was not news to the country or even that specific audience; similar proposals have long been part of Paraguay's progressive political discourse and, in large measure, formed part of Dionisio Borda's initiatives as finance minister in 2003-2005. Their novelty comes from the fact that the statement was reinforced by the words of a Nobel-prize-winning economist, rather than merely from the priest-turned-president, Fernando Lugo, even if the latter was the voice of the country's thousands of protesting peasants, who filled the capital's plaza to demand agrarian reform. Away from the mouths of such political discontents, local media has interpreted these policy positions as radical populist threats that are, if anything, more dangerous to the country's authentic development prospects, which they quickly shoot down by routinely dragging out tired references to the failures of Soviet and Cuban socialism. But Professor Stiglitz's ideas cannot be so easily dismissed, and, while his words obviously cannot easily neutralize the recalcitrance of the country's entrenched political and economic elite, they have most definitely reframed and renewed an otherwise stagnant and outdated debate over the role of government in economic development. By describing progressive tax and land reforms as crucial bases for economic growth, rather than obstacles to it, Stiglitz could be granting badly needed legitimacy to the newly elected government and its young economists who will be guarding the gates of civic rectitude.
In the April 15 balloting, voters handed Lugo a 42 percent to 31 percent victory over Colorado-Party candidate Blanca Ovelar, a clear mandate for reform. However, the electorate at the same time awarded a congressional plurality to the Colorados. The net result could be that Lugo may find himself squeezed between the unprecedented popular expectations for economic and social reform and the reality that conservative groups still control the legislature and could paralyze any kind of leftist dynamism. Lugo's success will depend on the chief executive's political savvy as well as his untested ability to manage the different factions within his own essentially formless legislative coalition, the Patriotic Alliance for Change, along with the opposition parties in order to build a consensus that could meaningfully alter the status quo.
If Stiglitz remains part of Lugo's advisoral team, he may prove an invaluable ally in this process when it comes to the big picture. Economic ideas, like those shared by Stiglitz only hours before the inauguration, do not simply provide a set of policy options that can be applied by governments or their technocrats in search of the best outcomes. The content of economic growth and development theories can end up providing tools which different groups appropriate in political debates over which interests should be formalized into policy and which should get beaten back at the door, turned down in the name of progress.
Throughout the 1990s, advocates of a compassionate social policy and protective regulations found themselves defeated and delegitimized at every turn by neoliberalists. Acolytes of neoliberal economics provided an account of the world in which the interests of society every time coincided with those of the private sector against what it saw as the bureaucratic public sector, leaving little room for the political left to function in real time. In much of Latin America, as in the US, the nineties proved to be the best of years for many businesses, mainly in the banking and financial sectors, along with those drawing top incomes from other private pursuits, but poor ones for most members of society. The view of economic development afforded by Stiglitz and other warriors intent on upholding a 'post-Washington Consensus', has not yet led to a coherent set of recommendations for developing countries, but what it has done is to categorically reject any one-size-fits-all policy.
However, scholars like Stiglitz clearly see a much larger role for government in bringing about positive economic development and social justice than any leading development institution envisioned a decade ago. In theory, Lugo's government stands to do a great deal of good in Paraguay, and Stiglitz has laid out some of the tasks that lie ahead. In practice, the new government's achievements will depend on how well progressive groups can capitalize on the spirit and letter of Stiglitz's ideas and re-conquer political spaces to unite their forces and plot their palace coups, that had been denied them for decades.
The original version of this piece appeared in a somewhat different form in UpsideDownWorld, under the title "Stiglitz Goes To Paraguay: Move Over Chicago, A Cambridge Boy's in Town". The author, Gustavo Setrini, is a COHA Research Fellow and a PhD candidate in Political Science at MIT.