Dutch Tulips and Emerging Markets: Another Bubble Bursts

During the first half of the 1990s, both economic and political events in developing countries defied all expectations. Nations that most thought would not regain access to world financial markets for a generation abruptly became favorites of private investors, who plied them with capital inflows on a scale not seen since before World War I. Governments that had spent half a century pursuing statist, protectionist policies suddenly got free market religion. It was, it seemed to many observers, the dawn of a new golden age for global capitalism.

To some extent the simultaneous reversals in government policies and investor sentiment were the result of external factors. Low interest rates in the advanced countries encouraged investors to look again at opportunities in the Third World; the fall of communism not only helped to discredit statist policies everywhere but reassured investors that their assets in the developing world were unlikely to be seized by leftist governments. Still, probably the most important factor in the new look of developing countries was a sea change in the intellectual zeitgeist: the almost universal acceptance, by governments and markets alike, of a new view about what it takes to develop.

This new view has come to be widely known as the "Washington consensus," a phrase coined by John Williamson of the Institute for International Economics. By "Washington" Williamson meant not only the U.S. government, but all those institutions and networks of opinion leaders centered in the world's de facto capital--the International Monetary Fund, World Bank, think tanks, politically sophisticated investment bankers, and worldly finance ministers, all those who meet each other in Washington and collectively define the conventional wisdom of the moment.

Williamson's original definition of the Washington consensus involved ten different aspects of economic policy. One may, however, roughly summarize this consensus, at least as it influenced the beliefs of markets and governments, more simply. It is the belief that Victorian virtue in economic policy--free markets and sound money--is the key to economic development. Liberalize trade, privatize state enterprises, balance the budget, peg the exchange rate, and one will have laid the foundations for an economic takeoff; find a country that has done these things, and there one may confidently expect to realize high returns on investments.