Beyond The 'Washington Consensus:' Economic Webs And Growth : 13.7: Cosmos And Culture The "Washington Consensus" on driving economic growth around the world has largely failed to turn the battle against poverty. An expanded theory of economic growth is needed to better spread the benefits of economic development.
NPR logo Beyond The 'Washington Consensus:' Economic Webs And Growth

Beyond The 'Washington Consensus:' Economic Webs And Growth

Do we need to go beyond the "Washington Consensus" to spur global economic growth? Romeo Gacad/AFP/Getty Images hide caption

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Romeo Gacad/AFP/Getty Images

Do we need to go beyond the "Washington Consensus" to spur global economic growth?

Romeo Gacad/AFP/Getty Images

A body of economic theory known as the "Washington Consensus" has guided attempts to spur global economic growth for over two decades. This Consensus has largely failed, and contemporary economic growth theory seems mostly at a loss to understand the failure.

Meanwhile, the disparity of income between rich and poor countries has grown from 4-to-1 in Adam Smith's time to 70-to-1 now. No one knows why.

Part of the Washington Consensus is based on the work of economist David Ricardo and his theory of national competitive advantage. Ethiopia is good at producing coffee, Alberta is good at producing wheat. The two should trade freely to their joint advantage. Unfortunately, this leaves both as what we call "sub-critical" economies that cannot endogenously generate a growing diversity of goods and production capacities, hence wealth and growth.

We propose an extension of growth theory based on the structure of economic webs and their sub-critical versus supra-critical expansion into an un-prestatable "Adjacent Possible" of the "econosphere" that may be of significant help in guiding attempts to to drive growth.

Four of us, myself, Naresh Singh, acting vice president of the Canadian Partnership Branch of the Canadian International Development Agency, Rohinton Medhora, vice president of programs at the International Development Research Centre in Canada and Ricardo Hausmann, of the Harvard Kennedy School and a past Finance Minister for Venezuela, have co-authored this post and hope, with others, to develop new economic growth theory beyond the Washington Consensus to guide practical economic aid on the ground.

Growth and development strategies are recognized to be in disarray by an increasing number of institutions and stakeholders. It used to be believed that short to-do lists were enough to guide countries to prosperity, whether they be the peace, easy taxes and a tolerable administration of justice of Adam Smith or the openness, sound money and contract enforcement of Larry Summers.

In 1990, John Williamson christened the "Washington Consensus." It advocated fiscal and monetary soundness, openness to trade and investment, financial liberalization and regulation, privatization, deregulation and secure property rights. It was boiled down to a 10-item policy checklist for governments to follow.

After two decades of major reforms in many countries that followed these principles -- with generous support from multilateral and bilateral agencies -- the results are, in general, surprising and disappointing. The star reformers have not been the star performers and no evidence has been found that these policies promoted growth, once extremely bad policy outcomes are excluded from the sample.

Explaining the disparity in wealth across countries was the question that led Adam Smith to write The Wealth of Nations in 1776. But at that time the income differences to be explained were of the order of 4-to-1. In the meantime, they have grown to over 70-to-1, despite knowledge of the to-do lists and billions spent on aid.

Much of the conventional approach to development strategies is based on the idea that growth and development happen naturally provided that the government does not make too big a mess of the areas under its control. What is required for growth is capital, education and technology.

Capital can be accumulated through savings and openness to world capital markets, while technology can be allowed to flow in through foreign direct investment and intellectual openness to the rest of the world. If education, stability and peace can be provided, growth and development should take care of themselves and countries should converge to the level of income that can be supported by the evolution of global technologies. It is this underlying assumption that makes the widening income gaps across countries so puzzling.

A fundamental problem with the standard economic description of the world is that it tries to account for growth and development as a very low dimensional process in which few elements increase in quantity, such as output and physical and human capital.

Output is just GDP, abstracting from the myriad of specific goods and services that are produced. Human capital is just years of schooling, abstracting from the millions of different tasks that individuals and organizations need to master. Physical capital is just a dollar amount, abstracting from the specificity of machines, buildings, power sources, transportation networks and other inputs. Governments provide peace, infrastructure and property rights, abstracting from the millions of pages of legislation they write, edit and extend and the thousands of government agencies that they fund and give marching orders to.

In reality, these aspects of the econosphere are in constant co-evolution and it is the rising complexity of the system that leads to growth and development. Countries evolve by moving to what I call the Adjacent Possible in this complex web of goods and services and productive capabilities. More complex countries have many ways in which they can recombine new capabilities with existing capabilities and products to make new goods and services. Poor countries are trapped by a lack of complexity and limited possibilities of evolving out of it.

Consider the following example: The invention of the computer in 1943 led, some 30 years later, to the opportunity to invent and successfully market the personal computer. In turn, wide sale of the personal computer created jobs, wealth, and opened the opportunity to invent word processing. In turn, word processing offered the opportunity to store word files, which offered the opportunity to share files among scientists at CERN. This technological progress led to the opportunity to invent the World Wide Web. Given the Web, it became possible to use this new niche to market products and eBay flourished. Content assembled on the web, offering the economic opportunity, the new niche, to make profit by inventing search engines and Google has done nicely. Now we have reached the summit of first world civilization with Facebook.

The above examples demonstrate what we know, but have little theory for: economic goods and services and production capacities engender novel goods, services and production capacities in what might be called the Adjacent Possible of the econosphere. We cannot pre-state the way the economy will create new goods and production capacities in the future. Not only do we not know what will happen, we do not even know what can happen.

What is needed is to develop a modified body of theory of economic growth and its policy implications for practical, on the ground, economic experimentation at one or several local or regional economies around the world in the next three years. We must aim at new ideas, not limited by a failed Washington Consensus, while including that which is wise in the standard view.

Are there possible principles governing the emergence of such possibilities? Some mathematical models by myself suggest that an economy with few goods and few production capacities is sub-critical and cannot generate a growing web of new goods and services and production capacities. Ethiopia seems to be sub-critical, producing coffee and thus remaining at the whim of the global coffee market, despite David Ricardo's national competitive advantage in coffee production.

Above a threshold in a coordinate space with diversity of goods on one axis and production capacities on the second, a curved line separates such subcritical economies from supra-critical economies, such as the United States, the European Community, and global economy, that can generate ever novel niches and goods and production capacities. Hausmann and colleagues have recently shown that, in fact, the diversity and richness of the "economic web" in a country correlates with wealth and growth and that, contrary to what emerges from Ricardo's ideas of specialization through comparative advantage, countries diversify as they grow and do so by moving towards the Adjacent Possible as measured by the revealed similarity of products.

Married to the above, standard growth theory, while considering research as a costly and potentially profitable activity which will make new goods, ignores the fact, emphasized by Brian Arthur in The Nature of Technology, that all technologies grow out of existing technologies. Research also exhibits the notion of expanding to its Adjacent Possible. This is the engine that is either trapped in sub-critical economies like Ethiopia, or expanding exponentially in supra-critical economies like China, Korea or the global economy. These are the ideas that are currently missing from the actual design and implementation of growth and development strategies.

We must focus on expanding growth theory to include what we think is missing. Beyond that stated above, there are growing grounds to believe that the way the economy grows cannot be finitely pre-stated. That means that we do not know beforehand the goods and services that may emerge. This is both true, see Silicon Valley and the story leading to Facebook, and it has two major policy implications:

1) Generative environments are needed, and we do not know how to create a supra-critical (local or regional) economy. Clearly, much of development is not related to the expansion of technological possibilities at the global level but the move towards goods and services that are known to the world but previously not yet feasible in a particular country.

2) Because we cannot know how growth will occur, we do not know how the millions of pages of legislation and the thousands of public entities that governments have need to be adjusted to facilitate and accompany the process of change. Standard economic and governmental policy planning, currently conceived as an exercise in adopting unconditional "best practice", need to be revised in ways that are still unclear. Probably, the solution involves thinking of the meta-structure whereby policies co-evolve with capabilities and production.

Thinking of environments in which this process can occur will be a major challenge. The interaction of economic agents, society in general and government is required to reveal the fine-grained information that an effective co-evolutionary process requires. We believe that a new union of standard growth theory, wisdom from the recent development experience, the ideas above, and yet further concepts, can transform our practice of aiding economic growth. The aim should be to have growth experiments on the ground in three years.