The churn in economic policy thinking

The several flaws of the Bretton Woods system of international cooperation exposed after 2008 need to be addressed

Policy economists are going back to the drawing board. The anaemic global recovery more than eight years after the North Atlantic financial crisis has led macroeconomists to either seek new prescriptions or revive old ones to get economies back on track. The political backlash in many parts of the world against inequality within nations—even as inequality at the global level has reduced because of the progress in China and India—has forced new discussions on development policy.

Exhibit A: The December issue of the Finance and Development quarterly published by the International Monetary Fund has several discussions about the distributional consequences of free trade. One underlying theme in these essays is that world trade has increased global welfare at the aggregate level but there has been no structured attempt to compensate the losers in order to ensure that nobody is worse off—the classic Pareto principle of welfare economics. This comes even as the multilateral lender has altered its position on a range of other issues such as the efficacy of fiscal spending or capital account convertibility. Japan has even been asked to toy with an incomes policy to deal with its weak consumer demand, a policy option that was last seriously considered way back in the 1970s.

Exhibit B: Thirteen of the best development economists in the world have this month released a statement in Stockholm outlining the new contours of development policy. This group includes four former chief economists of the World Bank, and three Indians—Kaushik Basu, Ravi Kanbur and Ashwini Deshpande. They begin by arguing that rapid economic growth is needed to spread opportunity as well as generate resources to fund social objectives. The Stockholm statement by these development economists stresses the need for programmes to address inequality, climate change and inclusive growth. One of the most interesting recommendations is to focus on social norms to build the sort of trust that is found in successful economies.

These are two of the most recent examples of fundamental rethinking about the goals of economic policy. It is important to recognize the risk of maverick politicians across the world throwing the baby out with the bathwater. For example, rising protectionist sentiment in many rich countries could threaten the open global trading system that has been the bedrock of economic progress. Similarly, it is hard to see how the poor can benefit when there is no macroeconomic stability because of reckless fiscal and monetary policies.

The problem in recent years has been one of overreach. Free trade agreements have been replaced by more ambitious attempts to harmonize regulations, protect the rights of investors and guarantee intellectual property—not the sort of issues that traditional free trade advocates would have argued for. In international macroeconomics, the Bretton Woods goal of current account convertibility was replaced by a push towards capital account convertibility to benefit the financial sector.

The new intellectual initiatives are undoubtedly welcome. Economic policy thinking has to keep up with the times. It has to develop new ways to deal with old problems. However, it is also important to get the basics right. There is irrefutable evidence that the biggest gains against global poverty have been made when markets allocate resources, trade barriers are low, taxes are stable, private property is protected, rules are more important than discretion and there is macroeconomic stability. What needs to be done is more explicit focus on issues such as inequality, climate change and skills.

The global system is now at an interesting juncture. This system was put in place after the terrible episodes of protectionism, macro instability and economic stagnation led to the slaughter in a world war. The Bretton Woods system of international cooperation segued the second wave of globalization after 1990, as the Soviet Union collapsed and countries such as China and India joined the world economy. There have been several flaws in this system that were exposed after 2008, but the economic progress as well as the improvement in social indicators during this period cannot be ignored either.

The backlash against globalization in many rich countries presents a profound challenge to the framework of global institutions. It is now imperative that countries such as China and India step up to the podium to protect the global system that has helped them make such dramatic progress over the past 25 years—and at the same time take a more active part in the ongoing intellectual churn—a modernsamudra manthan—that should hopefully lead to a new policy consensus.

Where did the Bretton Woods consensus go wrong?