The Washington Consesus: A Major Downside of Capitalism

Global Capitalism

Can it be made to work better?

NAIVETE. It all adds up to a breakdown of what was known as the Washington Consensus. The grandiose term refers to a world view pushed aggressively by the U.S. Treasury, the IMF, and the World Bank in the early 1990s. This dictum held that all countries should open their markets to trade, direct investment, and short-term capital as quickly as possible. The transition would be painful, but inevitably, markets would achieve equilibrium, and prosperity would result.

By: Pete Engardio in Washington, with Catherine Belton in Moscow, and bureau reports

It's hard to figure how a term that once connoted so much good for the world has fallen into such disrepute. In the past decade, globalization--meaning the rise of market capitalism around the world--has undeniably contributed to America's New Economy boom. It has created millions of jobs from Malaysia to Mexico and a cornucopia of affordable goods for Western consumers. It has brought phone service to some 300 million households in developing nations and a transfer of nearly $2 trillion from rich countries to poor through equity, bond investments, and commercial loans. It's helped topple dictators by making information available in once sheltered societies. And now the Internet is poised to narrow the gulf that separates rich nations from poor even further in the decade to come.

It's little wonder then that, for many, the rage now being vented against globalization is so perplexing. Even in this jittery autumn, as investors punish bourses and recession fears rise, many workers and government officials in nations such as China, Mexico, and Hungary still feel that the movement toward open markets has paid off. The tumultuous street theater of angry young middle-class Westerners vilifying multinationals and forming human chains to shut down meetings of bodies such as the World Bank, seems bizarrely detached from the real-life concerns voiced in countries that are supposed to be victims of global capitalism. Even in the toughest situations, there is little interest in returning to the past. ''The more open the Russian economy is to the rest of the world, the better,'' says Yevgeny Gavrilenkov, an architect of President Vladimir Putin's economic plan.

RETHINKING. Yet it would be a grave mistake to dismiss the uproar witnessed in the past few years in Seattle, Washington, D.C., and Prague. Many of the radicals leading the protests may be on the political fringe. But they have helped to kick-start a profound rethinking about globalization among governments, mainstream economists, and corporations that, until recently, was carried on mostly in obscure think tanks and academic seminars.

This reassessment is badly overdue. In the late 20th century, global capitalism was pushed by leaps in technology, the failure of socialism, and East Asia's seemingly miraculous success. Now, it's time to get realistic. The plain truth is that market liberalization by itself does not lift all boats, and in some cases, it has caused severe damage to poor nations. What's more, there's no point denying that multinationals have contributed to labor, environmental, and human-rights abuses as they pursue profit around the globe.

For global capitalism to move into the next stage will require a much more sophisticated look at the costs and benefits of open markets. To assess these increasingly important trade-offs, BUSINESS WEEK sent more than a dozen reporters around the world, from the deserts of Chad to the factories of Guatemala, to witness firsthand the effects of global capitalism. They met workers who toil 16 hours a day for miserly pay making garments sold in the U.S. as well as villagers who want oil companies off their land. But they also talked to factory laborers who have seen big gains in their standards of living as well as creative bureaucrats who have used markets to coax growth out of once moribund economies.

The overwhelming conclusion of this reporting is that there are many examples of where reckless investment has done harm--but there is no case where the hazards can't be addressed with better government and corporate policy. The real question isn't whether free markets are good or bad. It is why they are producing such wildly different results in different countries. Figuring out that answer is essential if businesses, government leaders, and workers are all to realize the benefits of global markets.

The extremes of global capitalism are astonishing. While the economies of East Asia have achieved rapid growth, there has been little overall progress in much of the rest of the developing world. Income in Latin America expanded by 75% during the 1960s and 1970s, when the region's economies were relatively closed. But incomes grew by only 6% in the past two decades, when Latin America was opening up. Average incomes in sub-Saharan Africa and the old Eastern bloc have actually contracted. The World Bank figures the number of people living on $1 a day increased, to 1.3 billion, over the past decade.

The downside of global capitalism is the disruption of whole societies, from financial meltdowns to practices by multinationals that would never be tolerated in the West. Industrialized countries have enacted all sorts of worker, consumer, and environmental safeguards since the turn of the century, and civil rights have a strong tradition. But the global economy is pretty much still in the robber-baron age.

If global capitalism's flaws aren't addressed, the backlash could grow more severe. Already, the once impressive forward momentum for new international free-trade deals has been stopped cold. An ambitious Multilateral Agreement on Investment, which would have removed all remaining restrictions on cross-border investment by corporations, fizzled last year. So have hopes for a new global trade round through the World Trade Organization. In the U.S., Congress has refused to give the President fast-track authority to strike new trade deals.

The longer-term danger is that if the world's poor see no benefits from free trade and IMF austerity programs, political support for reform could erode. The current system is ''unsustainable,'' says United Nations Assistant Secretary General John G. Ruggie, who, as a political economist at Columbia University, examined how previous golden ages of global capitalism, such as the one at the turn of the 19th century, unraveled. ''To survive,'' says Ruggie, ''it must be imbedded in broader social concerns.''

NAIVETE. It all adds up to a breakdown of what was known as the Washington Consensus. The grandiose term refers to a world view pushed aggressively by the U.S. Treasury, the IMF, and the World Bank in the early 1990s. This dictum held that all countries should open their markets to trade, direct investment, and short-term capital as quickly as possible. The transition would be painful, but inevitably, markets would achieve equilibrium, and prosperity would result.

In hindsight, it was a naive and self-interested view. Free capital markets, which have proved the most disruptive part of the formula, were largely championed by Wall Street--which saw new trading opportunities--over the objection of many economists. To be sure, developing nations badly needed to import capital and foreign financial knowhow to keep growing. But many nations simply couldn't handle the inflows. The results were huge white-elephant industrial and property projects that devoured funds and foreign-currency debt bombs that started exploding in 1994, first in Mexico and later in East Asia.

A more realistic view is now gaining hold. It begins with a similar premise: that trade and inflows of private capital are still essential to achieving strong, sustainable growth and to reduce poverty. But it acknowledges that multinationals--which account for the bulk of direct cross-border investment and one-third of trade--have social responsibilities in nations where the rule of law is weak. And it dispenses with the erroneous notion that open markets will magically produce prosperity in all conditions. Even the IMF now warns that a high degree of openness to global capital can be dangerous for some development. ''The IMF push for capital-market liberalization for all nations was driven by financial-market ideology,'' says former World Bank chief economist Joseph E. Stiglitz, now a vocal IMF critic. ''They have conceded defeat, but only after the damage was done.''

Even the orthodoxy that developing countries should quickly lower import barriers and slash the state's role in industry is being challenged. Before trade and foreign capital can translate into sustainable growth, governments first must deliver political stability, sound economic management, and educated workers.

NOT SO FAST. East Asia's Tigers had many of these features when they began their export drives; most of Latin America and Africa did not. ''To get the benefits of trade and capital flows, you need a broader base of development,'' says Dani Rodrik, a Harvard University economist whose research has raised hackles by suggesting that there is no automatic link between openness and growth in developing countries.

The search for a more intelligent approach to globalization is most evident within the developing nations themselves. Russia is only now starting to recover from the massive corruption, capital flight, and economic collapse of the 1990s. Putin's government plans to continue market reforms and wants to join the WTO. But its blueprint also calls for strengthening the legal system and control of the financial sector. ''There's an emphasis on long-term plans for economic development instead of the haphazard, piecemeal policies of the pre-crisis years,'' says Mikhail Zadornov, who was finance minister under Boris Yeltsin.

A similar view is forming in Romania, whose economy has contracted by 14% since 1996. The only way to achieve growth, says opposition Social Democracy Party legislator Adrian Nastase, is to make Romania more attractive to foreign investment, boost exports, and work with the IMF and World Bank. But he's also wary of importing pat formulas. ''We have been told that small is beautiful. We have been told to privatize as fast as possible. We have been told many things,'' says Nastase, who is expected to be Romania's next prime minister. ''But the teachers are changing the contents of the schoolbooks.''

Some countries face such immense challenges that it could take a decade before they benefit from lifting trade and financial barriers. Despite considerable liberalization, growth in sub-Saharan Africa has fallen from 3.5% in the 1970s to 2.2% in the 1990s. And foreign investment is negligible. ''Companies have nothing against Africa,'' says U.N. Development Program economist Salim Jehar. ''It's that stability, infrastructure, and skills are not there.'' The only way for sub-Saharan Africa to begin digging out is for foreign creditors to forgive most of its debt, which consumes some 40% of export revenue. Then, it must somehow attract massive infusions of private investment.

Just as there are no one-size-fits-all policies for economic development, there also are no clear roadmaps for corporate behavior. Balancing growth with environmental and labor regulations is wrenchingly complex in countries where people live on the margin. Many poor nations fiercely resist discussion of labor or environmental issues in the WTO because they fear the process will be hijacked by Western protectionists: The feeling is that Western unions will shield jobs at home by imposing standards that drive up labor costs in emerging markets to levels where developing nations can't compete. ''It's hypocrisy of the first sort for the West to talk about opening borders and then hide behind barriers,'' says Indian economist Surjit Bhalla.

The result, however, is confusion. At a time when image is paramount, corporations are besieged with activists who harangue executives at shareholder meetings, organize consumer boycotts, smear their brand names on the Web, and pressure creditors and shareholders alike. To allay critics, companies such as Nike ( NKE), Mattel ( MAT), Levi Strauss, and Royal Dutch Shell Group ( RD) have drawn up their own guidelines and invited monitors to ensure that they live up to them.

''People's expectations of the social and environmental role of businesses have absolutely changed in the past five years,'' says Aron Cramer, vice-president of San Francisco's Business for Social Responsibility, which advises the Gap Inc. ( GPS), General Motors Corp. ( GM), and other companies on their practices abroad. ''If there's a problem in a company's global supply chain, all it takes is one modem in Indonesia to alert the world about it.''

But altering business practices to appease pressure groups can also hurt more than help the impoverished if they are done hastily. For example, soon after a bill was proposed in the U.S. Congress in 1993 to ban imports from countries where children work in factories, garment makers in Bangladesh fired 36,000 workers under age 18, most of them girls. Studies by the International Labor Organization and Unicef found that few of the fired workers ended up in school. Instead, many took more dangerous jobs or became prostitutes. ''Instead of just throwing children out of work, you first must address the underlying economic conditions,'' says Nandana Reddy, director of India-based Concern for Working Children.

Partly to avoid having extremists set the agenda, efforts are now under way to clarify the rules. In May, the U.N. kicked off a program called Global Compact. The idea is to get multinationals to endorse a set of basic human rights, environmental, and labor principles, and allow private groups to monitor their compliance. So far, some 44 companies, including Shell and Nike, have signed up.

SANCTIONS. Because industry self-regulation schemes lack real teeth, critics dismiss them as merely public relations. But such pacts are beginning to form the basis of a kind of global capitalism with rules. There already are international agreements on intellectual-property rights, prison labor, and trade in endangered species that allow countries to bar imports from violators.

As the costs of consumer boycotts and monitoring rise, companies and their investors are likely to look toward more uniform standards of behavior. But make no mistake: It's unlikely that anyone would agree to an international central bank policing the capital markets or world legislatures and regulatory agencies enforcing good corporate behavior. The new rules of global capitalism will evolve slowly, in pieces, and with varying degrees of success.

A serious discussion on globalization has begun. Until now, it has been dominated by extremists on both sides--anti-globalism radicals and dogmatic free-marketers. ''At each end of the spectrum are ideologues who are pushing agendas unrelated to reality,'' says World Bank development research director Paul Collier. ''It has been a dreadfully silly debate.''

A decade ago, when much of the world was still clinging to various brands of wealth-destroying socialism, it may have made sense to push rigid doctrines. But the battle for market-driven economics has been largely won. And the flaws of trying to force every country into the same template have become clear. To take globalization to the next level, it is time to forge a more enlightened consensus.