Earlier this month, the G7 Economic Resilience Panel released a report that questioned the wisdom of market-led development, as promoted by the so-called Washington Consensus, and advocated a new economic paradigm (NEP)—the Cornwallis Consensus—in which the state would play a major role.

Mariana Mazzucato, a member of the panel and the author of The Entrepreneurial State: Debunking Public vs. Private Sector Myths, summarized the different approaches in a recent article in Project Syndicate:

Whereas the Washington Consensus minimized the state’s role in the economy and pushed an aggressive free-market agenda of deregulation, privatization, and trade liberalization, the Cornwall Consensus (reflecting commitments voiced at the G7 summit in Cornwall last June) would invert these imperatives. By revitalizing the state’s economic role, it would allow us to pursue societal goals, build international solidarity, and reform global governance in the interest of the common good.

Mazzucato’s view of the relationship between the state and the market, in the process of economic development, is in sharp contrast with Peter Bauer’s emphasis on limited government, the rule of law, private property, and free trade as key factors in creating economic and social harmony. The role of government, according to Bauer, is to safeguard persons and property so that free markets can widen the choices open to people and improve their lives.

The fact that governments are coercive by nature, while markets, bounded by a genuine rule of law, are consensual, should put people on guard against the idea of an “entrepreneurial state.” In particular, assigning a large role to the state in the process of innovation and technological advance is not risk free.

Nevertheless, Mazzucato’s views are gaining widespread attention, and the G7 panel’s Economic Resilience Report is sure to be discussed at the G20 summit this weekend, when leaders consider the challenges facing the global economy, including the COVID-19 pandemic, climate change, inequality, and “economic fragility.”

This blog post considers Mazzucato’s case for a NEP, which diminishes the role of markets and enhances the power of the state, and whether that paradigm offers a better chance of achieving economic resiliency than the market-liberal model favored by Bauer. In doing so, I will also examine Mazzucato’s portrayal of the “Washington Consensus” to see if accurately describes the idea John Williamson first introduced in 1989.

Mazzucato’s New Economic Paradigm

Mazzucato’s case for a NEP, as stated in her Project Syndicate article, stems from her view that “something must replace the Washington Consensus if we are to flourish, rather than simply survive, on this planet.” As she asserts, “Only renewed international cooperation and coordination of enhanced state capacities—a new social contract underwritten by a new global consensus—can prepare us for tackling the escalating, interlocking crises ahead.”

Her confidence in state action and international cooperation is more romance than reality. She largely ignores government failure and public choice theory while overplaying the concept of “market failure.” It is widely accepted that, in the case of serious externalities or public goods, there is room for government action. However, that fact does not mean we should automatically expect state and collective action to bring about outcomes consistent with the “common good.” Indeed, enhancing the power of the state risks politicizing economic life, diminishing individual freedom, and increasing the probability of moral hazard—that is, increasing risk taking when individuals are not fully responsible for their actions.

Although Mazzucato wants to have a strong public-private partnership to solve complex problems, too much state support can derail the price and profit system that has been the dynamic element in motivating people to be resilient and create wealth. When the private, free-market system is constrained by an intrusive government, the likely result is not more wealth but more coercion and less freedom.

Under Mazzucato’s, and the G7 panel’s, blueprint for economic resilience, state investment would increase significantly and be allocated by “new contractual and institutional mechanisms that measure and incentivize the creation of long-term public value rather than short-term private profit.” At least that is the plan. Yet no one has devised an incentive system that can rival that found in a competitive free-market economy.

Bauer’s Market Liberalism

Do we really need “a radical reorientation in how we think about economic development,” as Mazzucato proclaims in her Project Syndicate article? Would a more state-centric model of development generate the results postulated by Mazzucato, or is Mazzucato’s Cornwall Consensus approach to economic resiliency plagued by what Peter Bauer called “the disregard of reality”?

Peter Bauer was a pioneer in development economics. He questioned conventional wisdom holding that state-led development, import substitution, and foreign aid were the proper path toward development following World War II. In his study of West African trade and the Malayan rubber industry, Bauer found that:

A developed infrastructure was not a precondition for the emergence of the major cash crops of Southeast Asia and West Africa. As has often been the case elsewhere, the facilities known as infrastructure were developed as the economy expanded.… What happened was in very large measure the result of the individual voluntary responses of millions of people to emerging or expanding opportunities created largely by external contacts and brought to their notice in a variety of ways, primarily through the operation of the market. These developments were made possible by firm but limited government, without large expenditures of public funds and without the receipt of large external subventions.

From his observations and careful analysis, Bauer concluded that the plight of underdeveloped countries is not so much market failure as the failure of government to protect personal and economic liberties—and to allow markets to operate freely, both with regard to domestic and international trade. According to Bauer,

The literature of market failure has been used largely as a collection of sticks with which to beat the market system. The critics who propose replacing the market system by political decisions rarely address themselves to such crucial matters as the concentration of economic power in political hands, the implications of restriction of choice, the objectives of politicians and administrators, and the quality and extent of knowledge in a society and of its methods of transmission.

Like Adam Smith and other classical liberals, Bauer took a broad view of economic development. In his 1957 book, Economic Analysis and Policy in Underdeveloped Countries, he argued that “the principal objective and criterion of economic development” is “the extension of the range of choice”—that is, “an increase in the range of effective alternatives open to people.” Hence, the emphasis is on the institutions needed to expand the scope of markets, particularly the role of government in safeguarding persons and property.

Unlike many of his contemporaries, Bauer emphasized the dynamic gains from trade. He saw external trade as beneficial because it widened the range of choice, provided for the diffusion of knowledge, and increased the wealth of nations. Getting rich is not a zero sum game, with one person gaining at the expense of others. As Bauer noted in his essay, “Market Order and State Planning,”

The market order minimizes the power of individuals and groups forcibly to restrict the choices of other people. Forcible restriction of the choice of others is what coercion means. Possession of wealth does not by itself confer such power on the rich. Indeed, in modern market economies the rich, especially the very rich, usually owe their prosperity to activities which have widened the choices of their fellow men, including those of the poor.

Finally, Bauer rejected the idea that investment was a critical determinant of economic development or that a general theory of development was feasible. Instead, he recognized the complexity of the development process and studied the actual behavior of people in less developed countries as they moved from subsistence to exchange. From his field work, he concluded that economic development depends on institutions, culture, and conduct, not on planning, large-scale state investment, or natural resources:

Economic performance depends on personal, cultural, and political factors, on people’s aptitudes, motivations, and social and political institutions. Where these are favorable, capital will be generated locally or attracted from abroad [in Dorn: 364].

From his observations, he held that “It is more meaningful to say that capital is created in the process of development, rather than that development is a function of capital” [ibid.: 365].

Bauer’s critique of conventional development economics bore fruit, and by 1997 the World Bank, in its World Development Report, recognized the idea that “good advisers and technical experts would formulate good policies, which good governments would then implement for the good of society” was naive. According to the report, “Governments embarked on fanciful schemes. Private investors, lacking confidence in public policies or in the steadfastness of leaders, held back. Powerful rulers acted arbitrarily. Corruption became endemic. Development faltered, and poverty endured”—exactly as Bauer had predicted.

Mazzucato appears to be unaware of Bauer’s contributions to development economics. Yet some of Bauer’s recommendations appear under the rubric of the “Washington Consensus,” which is the prime target of her criticism and the basis for her call for a NEP.

Williamson’s Washington Consensus

In 1989, John Williamson, a scholar at the Institute for International Economics in Washington, D.C., presented a list of 10 policies that the World Bank, International Monetary Fund, and U.S. Treasury generally accepted as conducive to economic development, particularly with regard to Latin American countries. That list, known as the “Washington Consensus,” was not meant to be an exhaustive list or a blueprint for development. Nor was it a recipe for minimum government or neoliberalism, as claimed by Mazzucato. As Williamson noted in his January 13, 2004, lecture at the World Bank,

The Washington Consensus as I originally formulated it was not written as a policy prescription for development: it was a list of policies that I claimed were widely held in Washington to be widely desirable in Latin America as of the date the list was compiled, namely the second half of 1989. Of course, development was the main objective of the countries in question; the point is that my agenda excluded policies even if I believed they would promote development unless I was also convinced that they commanded a consensus.

His list included privatization of state-owned enterprises, removing barriers to foreign direct investment, safeguarding property rights, opening markets so new firms to enter, abolishing nontariff barriers to trade and lowering tariffs, improving flexibility in the exchange-rate regime, promoting financial liberalization, and encouraging fiscal discipline and sound money. That agenda, when implemented, helped Latin American countries expand the range of choices open to people by expanding the scope of the market and limiting the power of the state.

In his World Bank lecture, Williamson tells us that soon after he had written his 1989 paper he became “interested in the transition from communism to a market economy that was then in its early stages.” He was convinced “that institutional issues were, or at least should be, at the heart of the transition, and that one of the most critical actions was defining property rights.” Consequently, he was confident that “this theme deserved a place in the Washington Consensus.”

Peter Bauer would agree. By disparaging the Washington Consensus as understood by Williamson and neglecting the work of Bauer, Mazzucato falls into the trap of setting up a strawman. She ignores the success of market liberalism in fostering human progress while naively promoting the myth of the “entrepreneurial state”—a myth that Deirdre McCloskey and Alberto Mingardi have thoroughly exposed.

Although Williamson did not think of his list as a prescription for reform, he clearly recognized that:

Most countries would have benefited by doing more of these reforms rather than fewer, and by doing them of their own volition rather than because someone from Washington tried to tell them they needed to be done. The big changes in development thinking that underlay the Washington Consensus—recognition of the importance of macroeconomic discipline, trade liberalization rather than import substituting industrialization, development of the market economy rather than reliance on the leading role of the state—were as valid in developing countries as they had long been regarded in the OECD.

Conclusion

In her Project Syndicate article, Mazzucato argues that, “World leaders have a simple choice: continue supporting a failed economic system, or jettison the Washington Consensus for a new international social contract.”

When the leaders of the G20 meet this weekend to discuss ways to increase economic resilience in dealing with the pandemic, climate change, and equity issues, they would benefit from listening to market-liberal voices, not just those who have a romantic view of the “entrepreneurial state.” As McCloskey and Mingardi remind us, “the Great Enrichment came not from the state but from liberty.” Institutional reforms that enhance the scope of the market and limit the power of the state are more likely to create social and economic harmony than attempts to revitalize state-led development “in the interest of the common good.”