Joe Biden’s new deal threatens global prosperity

Roger Partridge
NZ Herald
10 May, 2023

Sometimes change is sudden. At other times, it creeps up slowly and is only obvious looking back. Yet such change can be no less profound.

The demise of the Washington consensus is a change of this second type. But its implications may be even more significant than last year’s abrupt return of war to Europe or the Covid-19 pandemic that enveloped the world a year earlier. Indeed, a speech late last month from President Biden's National Security Adviser, Jack Sullivan, to the Brookings Institute signals a fundamental dismantling of world’s established economic order.

The "Washington consensus" describes a set of economic policy prescriptions that had become accepted wisdom among policymakers and international financial institutions based in Washington D.C. by the end of the 1980s. These institutions included the International Monetary Fund, the World Bank, and the U.S. Treasury Department.

The term was first coined in 1989 by John Williamson, an economist at the Institute for International Economics. It became widely used in the 1990s to refer to policies that emphasised free-market principles.

The policies were a response to the economic crises and inflationary pressures that both developed and developing countries were experiencing in the 1980s. The policies promoted fiscal discipline, trade liberalisation, and deregulation.

Under the consensus, the tax and transfer system aside, the state’s economic role was limited to creating an environment conducive to economic growth and development rather than as an active participant.

The benefits of the Washington consensus are hard to overstate. According to the World Bank, between 1981 and 2013, more than a billion people escaped extreme poverty. Annual GDP-per-capita globally increased more than four-fold. And countries like the Eastern European states and most Southeast Asian nations experienced major economic growth and poverty reduction from adopting the principles of the consensus.

Yet, this century, the consensus has been under pressure. For starters, successive U.S. administrations have paid only lip service to its fiscal discipline limb.

The Obama administration argued that large deficits were necessary to stimulate the economy after the 2008 financial crisis. However, the U.S. budget deficit remained above $1 trillion for each of Obama's first four years in office.

The consensus came under more direct fire when Donald Trump became President in 2016. Trump was a vocal critic of multilateral trade agreements such as the North Atlantic Free Trade Agreement and the Trans-Pacific Partnership. And he expressed scepticism towards international institutions allied to the Washington consensus, like the World Trade Organization and the International Monetary Fund. Instead, Trump pursued a policy of economic nationalism, placing tariffs on imports and seeking to renegotiate existing trade deals.

At the same time, the pre-pandemic increase in the U.S. budget deficit during the Trump administration represented a profound departure from the Washington consensus's emphasis on fiscal discipline.

But if the Trump administration posed a threat to the consensus, the Biden administration has become its sworn enemy.

As outlined by Sullivan, Biden’s vision is no longer for the U.S. to champion free trade and limited government. Instead, he explains Biden is “pursuing a modern industrial and innovation strategy, both at home and with partners around the world.” Under this strategy, the Biden administration will pick winners. It will invest in “the sources of our economic and technological strength,” spending trillions of dollars.

In doing so, Sullivan says the administration will set “high standards” for everything from labour market regulation to taxation policies and governance. Standards its trading partners will have to follow.

Just how profound a change this represents from the Washington consensus requires a bit of unpacking.

First, Biden’s spending plans are eye-watering. A trio of measures - the $1.9 trillion American Rescue Plan, the $2.3 trillion American Jobs Plan, and the $500 billion (and comically-named) Inflation Reduction Plan - are aimed at boosting the economy and addressing various domestic policy priorities. While the administration argues that these spending plans are necessary to address long-standing issues like income inequality and infrastructure deficits, they will lead to deficits that are unprecedented for times of growth. Fiscal discipline be damned.

Second, the speech signals a dramatic change in the role of the federal government. Rather than creating an environment conducive to economic growth and development, the Biden administration proposes to sit in the driver’s seat. And not just on issues like securing the supply of computer chips that raise national security issues. Biden’s vision is for federal government-led economic development.

But, as I wrote in this column recently, the idea of state-led business and innovation policies is merely a re-packaging of failed policies from the past. And there is good reason they fell from grace. History is littered with examples of catastrophic “think big” type state-funded projects. So much so that Harvard professor Josh Lerner chronicled them in a best-selling book, Boulevard of Broken Dreams.

Despite Biden’s grandiose goals, countless economic studies suggest that creating a favourable economic environment for private firms to operate in is the key to innovation. It is a fatal conceit for politicians and bureaucrats to think they are better than competitive markets at predicting demand.

For example, a major interdisciplinary research programme conducted between 2013 and 2018 by the Ratio Institute in Sweden found the state can best improve well-being by focusing on the supply of human capital (for example, by improving the education system or favourable immigration settings), the flexibility of labour markets and reducing both taxes and the regulatory burden faced by firms.

Biden’s new deal will not end well for the U.S. economy. History tells us this kind of government intervention is inefficient, leads to misallocation of resources, and ultimately undermines economic growth. That will harm U.S. consumers, workers and taxpayers.

As the U.S. is the world’s largest economy, all its trading partners, including New Zealand exporters, will also feel the effects indirectly.

But it is the direct effects of the second aspect of Biden’s so-called new consensus that will be of most concern to America’s trading partners. The administration has signalled a desire to prioritise domestic economic concerns over international cooperation. And its talk of “high standards” is simply code for a more protectionist approach to trade.

The new approach will reach into the domestic economies of its trading partners and ensure neither tax rates nor other regulatory settings create undue advantages for foreign firms over their U.S. competitors. Yet those policies make an important contribution to the differences between nations on which the gains from trade and global prosperity are based.

Sullivan protests that the idea is not “America alone.” But that is exactly what it is. It marks a profound change from the commitment to multilateral free trade at the heart of the Washington consensus.

The Biden administration may claim the world has nothing to fear from his new deal. But trading nations, especially those with small economies like New Zealand’s, depend on the rules-based international order the consensus created.

As the U.S. turns its back on the Washington consensus, Biden may be promising a new deal. But it will prove a raw deal for American workers, consumers and taxpayers - and for everyone else.

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