The Three Pillars of Failure and Success

The emerging markets are an oasis of prosperity, while most of the developed world wallows in crisis. This is unfamiliar territory for most economists and investors. For decades, the emerging markets were embroiled in political, social and economic instability. Moreover, problems in the developed world usually triggered massive unrest in the developing world. However, the situation changed dramatically during the last few years. Not only did the emerging markets decouple from the developed world, one could argue that it is now the driver of global growth and stability. In other words, events in the emerging markets could serve to either stabilize or destabilize the rest of the planet. Of course, this should not be any surprise. The emerging markets represent 88% of the world’s consumers. Europe, the U.S. and Japan represent less than 12% of the globe’s population. However, variances in education, prosperity and capital accumulation allowed it to have a much larger slice of the global economic pie. Per-capita incomes in the west were huge multiples of those found throughout Latin America, Africa and Asia. However, the tide began to change more than a decade ago. The developed world slowly began relaxing its commitment to fiscal and monetary austerity. Meanwhile, the emerging markets developed a new affinity for flexibility and thrift.

The Asian, Russian and Latin American debt crises of the late 1990s, left indelible scars on the collective psyche of regional policymakers. Indeed, the origins of all three crises could be traced back to the prescriptions of the so-called Washington consensus. In the words of John Williamson, the author of the manifesto, ‘the three pillars of the Washington Consensus were stabilize, privatize and liberalize.’ Although there were some sound policy recommendations, such as fiscal discipline and tax reform, many others were dangerous if hastily done. Unfortunately, sensing billions (if not trillions) of dollars in potential fees to be earned, Wall Street banks became the new acolytes of the so-called Washington consensus. Bankers and analysts fanned out throughout the globe urging governments to embrace its policies. In order to speed up the process, emerging market government’s pegged their currencies in order to rapidly reduce their inflation rates. They liberalized their capital controls, thus allowing massive inflows. They quickly privatized state-owned companies, without the proper regulatory framework in place—in the process transforming public monopolies into private ones and creating some of the richest people on the planet. By the end of the 1990s, the emerging market countries found themselves with overvalued currencies, huge external imbalances and high debt loads. Starting with Asia in 1997, the major emerging market countries were engulfed in a maelstrom of financial distress. These crises usually culminated in maxi-devaluations and sovereign debt defaults. Forced to fend for themselves, emerging market governments reduced their ambitions. Throughout most of Asia and Latin America, governments adopted flexible exchange rates. They took steps to increase their sources of domestic savings and accumulated international reserves. Russia took similar steps. These three policy prescriptions became the new pillars of success, and the reason why the emerging markets are now an oasis of prosperity.

At the same time, the developed world began drinking its own kool-aid. At the very moment that the emerging markets’ fixed exchange rate regimes were engulfing their economies in flames, most of the Western European countries were embarking on a similar odyssey by adopting the euro. Of course, Wall Street was there to give a helping hand. Cloaked with the respectability of an investment grade wrapper, the Euro zone accumulated trillions of dollars of debt and financial obligations. Moreover, the mantra of liberation and deregulation allowed the proliferation of household debt and questionable financial products that undermined balance sheets and businesses throughout most of the western world. In the end, the policy prescriptions of the Washington Consensus created a new class of superrich, but it also delivered powerful lessons to emerging market governments that allowed them to reverse their policies and eventually become the most dominant economies on the planet.