Washington Consensus & FDI: Impact on Developing Economies

The Washington Consensus: Policies and Origins

The concept and name of the Washington Consensus were first presented in 1989 by economist John Williamson, who used the term to summarize policies advised by Washington-based institutions such as the International Monetary Fund (IMF), World Bank, and U.S. Treasury Department. These policies were believed to be necessary for the recovery of countries in Latin America from the economic and financial crises of the 1980s. These key policies include:

• Downscaling of government
• Deregulation
• Trade liberalization
• Liberalization of capital flows
• Privatization

Foreign Direct Investment: Drawbacks for Developing Nations

Foreign Direct Investment (FDI) refers to a company's physical investment into building a plant in another country, the acquisition of a foreign firm, or investment in a joint venture or strategic alliance with a foreign company in its local market. Investment may take place due to various reasons, including cheaper wages and special privileges (such as tax exemptions).

Since investors often seek the highest returns globally, they are frequently attracted to regions rich in natural resources and with less stringent environmental regulations. Consequently, both local communities and the environment may suffer due to investors' pursuit of economic gains, potentially leading to neglect.

Key drawbacks of FDI for developing countries include:

• Limited Currency Inflow: FDI may not necessarily bring in significant net currency, as profits often go back to the investing firm's home country.
• Increased Import Demand: The new company may source materials or components from its home country, potentially increasing imports for the host nation and boosting exports for the home country.
• Transfer Pricing & Free Riding: Local Transnational Corporations (TNCs) may act as separate businesses from their parent companies, leading to inflated costs on paper and lower visible profits locally, which can reduce local tax revenues.
• Concerns with Brownfield Investment:
  • View to Exit: Companies may acquire existing firms with the intention to move to a different country later, leading to instability.
  • Asset Stripping: An acquiring company might purchase a local firm primarily to sell off its valuable assets rather than developing the business.
• Limited Spillover Effects:
  • Formation of Enclaves: The benefits of additional investment may not be fully reaped by locals, with profits often returning to the home country, creating isolated economic zones.
  • Destruction of Local Firms: Foreign companies, especially those with significant resources, can often outcompete and displace successful local businesses, hindering indigenous growth.
  • Retention of High-Value Activities: Most valuable activities, such as creative work, research and development, or corporate headquarters, tend to remain in the home country, limiting technology transfer and skill development locally.