Andrés Velasco is the Dean of the School of Public Policy at the London School of Economics and Political Science.
In this week’s conversation, Yascha Mounk and Andrés Velasco discuss whether the Middle East war will trigger a 1970s-style economic crisis, why AI valuations could spark the next financial meltdown, and what signs to watch for in predicting future market crashes.
This transcript has been condensed and lightly edited for clarity.
Yascha Mounk: I really look forward to talking about the big questions of principle about what we should be trying to achieve with economic policy. But it’s hard not to start by talking about the current economic situation. The war in the Middle East has led to the closing of the Strait of Hormuz, and to the destruction of a lot of oil and gas infrastructure in the Middle East. Energy prices are up, and some people are starting to say that the shock that this will cause will turn out to be equivalent to the oil price shock of the 1970s. How permanent and how bad do you think the impacts of this war are likely to be at this stage?
Andrés Velasco: Clearly the picture is not pretty and we need to worry for several reasons. The first one is that the economy hates uncertainty, and today we’re facing uncertainty on so many fronts—tariff policy, the war, pretty much everything that the United States does today. So the headline is terrible.
Secondly, I think the war has revealed something we should have known all along, but we hadn’t really, which is that Iran can impose a massive cost on the world by simply controlling that one point. Many people, as I’m sure you know, worry that this may be a playbook, of course, for China and Taiwan. That is not a pretty picture.
The good news, I think, is that per unit of GDP, we depend less on oil than we used to. Oil remains very important, of course, and it’s politically very important because people hate to go to the gas station and find that prices are up, but to produce the stuff that we need to produce, oil is less necessary. The other reason why I don’t think that we’re quite back in the 70s yet is that back then you had really bad monetary policies. You didn’t have autonomous central banks. You didn’t have a track record of low inflation. Central banks are easy to hate, but they’ve done a pretty good job. I think they will be a stabilizing force going forward, even if the price of oil remains high.
Mounk: In a lot of the debate, there’s a question of whether the obvious temporary spike in oil prices is going to prove very long lasting. The assumption in the background seems to be: if the spike in oil prices proves long lasting, then we’re back in the 1970s. What you’re saying is that we’re not going to be back in the 1970s because oil was just much more important to an economy that still was in very large parts industrial.
The other thing to note here is that the United States in particular, which is a huge share of the global economy, has just become virtually independent and autonomous on oil and gas. The fracking revolution really means that most of the energy consumed in the United States today does not come from the Middle East, and therefore the American economy is less exposed to those effects.
Velasco: I think that’s right, but let me add two caveats. One caveat is that we need to be precise about what it is that we mean by being back in the 70s. In the 70s, the crucial word was stagflation—that is, stagnation and inflation. Stagnation could be an issue. The world economy outside the United States hasn’t been growing a lot. China grows a lot less than it used to. India does pretty well, but of course Europe doesn’t grow very much, Latin America doesn’t grow very much, much of Africa doesn’t grow very much. So slow growth is a danger.
The other component of stagflation, of course, is inflation. There I think we are on safer ground. You can have a one-time spike in prices, and that means higher inflation over a month or two or three. But a return to high inflation, I think, is pretty unlikely. The reason is that we have these institutions called central banks, and they showed us—for instance, in the inflationary episode after COVID—that you can have a spike in inflation. We had a year of very high inflation: the United States, the UK, other countries at 10, 11%. But without a big cost, inflation went down. It’s not guaranteed they can pull it off again and again and again, but I think monetary policy is much better run and we have many more monetary policy tools than we did a generation ago. So on that account, I think we are in reasonably good shape.
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The other thing I was going to say is that the real danger is not so much inflation. The real danger is that this moment of craziness, from the point of view of American policymaking, could trigger other things that today are under the rug, but which can blow up in a big way. That is finance. Ultimately these crises become crises not if you have a little bit more inflation, and not if you have half a point less of growth—it’s when the financial sector implodes. I don’t think we’re quite there yet, but there is a list of things that people worry about.
One of them, of course, is AI. Nobody doubts that AI will be good for productivity, but it’s not clear that the current valuations of AI stocks and technology stocks are reasonable. It’s also not clear that the investment boom in data centers is justified. It’s also not clear that other areas of the financial picture—particularly what Wall Street calls the private credit market, which are not banks, but other people providing private credit—are on solid footing. One can tell a story in which a lot of those institutions are vulnerable and they could take a hit. So I think the real danger—and again, we’re not quite there yet, but we should be thinking about it—is a financial multiplier. When finance gets out of whack, as it did in 2008/9/10, then we really have to worry.
Mounk: We’re trying to read tea leaves, and I think you’ve set out really nicely what the factors of stability are—why perhaps the oil price shock is not going to be as bad as the 1970s—but also what the tail end risks are. What the kinds of things are that could get us into a recession that could, in theory, spiral out of control. Of course, the old joke is that economists have successfully predicted 17 out of the last three recessions, and also that sometimes they fail to predict the recession that’s around the corner.
Velasco: I should point out that I’m recording this from the London School of Economics, where the late Queen Elizabeth came to cut the ribbon on a building in the middle of a financial crisis and asked one of my colleagues here—who was two doors down from me—how come you didn’t see it coming? The Queen wondered in 2008, how was it that so many economists had missed the big financial crisis? The answer is: ex post, we can tell you what went on, but ex ante, we’re not so good at predicting these things.
So could it be that around the corner we are going to face another financial blow up? Yes. As an academic, I specialize in financial crises. One thing I can tell you is that somewhere in the world there is one every five years. We haven’t really had one for about 15 now, so maybe it’s time for one.
Mounk: That’s very interesting. Since it is your academic specialty, what are the signs to look for in advance of a financial crisis and why is it so hard to predict them?
Velasco: The great Stanley Fischer, who was the vice chair of the Federal Reserve and the governor of the Bank of Israel and a professor at MIT, used to say: all my students are writing papers on the last crisis, nobody’s writing papers on the future crisis. The reason for that, of course, is that we don’t know what it will look like. Finance is a many-headed monster.
Nobody would have predicted that the crisis of 2007 and 2008 would begin in the mortgage market. Mortgages were supposed to be boring, were supposed to be safe. But there was an innovation in mortgage markets, and mortgage markets became something called asset-backed securities. Suddenly that very safe asset became unsafe. The first large institution to go under in 2008 was AIG—an insurance company—and people thought insurance companies were big and boring, that they cannot go under. But AIG came very close to the edge.
So where will the thing blow up next time around? If I knew, I’d be rich, but I’m not. The obvious two candidates are everything connected to technology, and particularly people who have made bets on these massive valuations of technology companies. Let me put it this way. If in fact the stock price of every major technology company—including Nvidia and Apple and Alphabet and everybody else—is right, the increase in GDP in the United States and the increase in exports by the United States is humongous. So ten years from now, the question will not be about the U.S. trade deficit, it will be about the U.S. trade surplus. That is if these valuations are right. But the truth is we have no idea if they’re right.
Mounk: The idea is that the valuations of these companies are so enormous. Valuations, of course, are based in large part on the expectations of future returns. So effectively, when you look at how much Nvidia is worth, how much some of these other tech companies are worth today, these are bets that they’re going to be selling enormous amounts of chips—in the case of Nvidia, for example. That can’t just be domestically in the United States, given the size of those bets; they have to be selling to countries around the world. The United States for a long time has had this huge trade deficit. Either the valuation of Nvidia just crashes down to levels that are much lower than they are today, or it basically implies arithmetically that the United States is suddenly going to have a trade surplus. Which of those two things do you think is going to happen?
Velasco: Again, it’s very, very hard to say, but let me spell it out in a bit more detail because the point you’re making is very important here. The price of a stock today, as you pointed out, is dependent on our guesses about how much the company will make—what the return on that company will be next year and the following year into the indefinite future. So if I look at the price of the stock of any large tech company today—and this includes not just the AI companies, Amazon for instance and others—they are suggesting humongous profits.
So one of two things must be right. If the people pricing these stocks today are correct in what they’re doing, the boom in productivity and in output and in U.S. exports is going to be gigantic. The issue of the 2030s will be how the world accommodates that. How can the rest of the world pay for these massive American AI-led services? But there’s an alternative scenario: that the calculations are wrong—I shouldn’t say calculations, these are educated guesses. One day we will wake up and realize that this stock is not worth 100, it’s only worth 50. At that point, a lot of things could go wrong, because people have borrowed against these stocks, they’ve used them as collateral, they’ve made investments based on these guesses. At that point, the stress on the financial system would be huge. Which one of the two will it be? I have no idea. As usual, something in between—but I couldn’t tell you exactly where in between.
Mounk: What about fears of an AI bubble more broadly? One company whose valuation is now very high is OpenAI. They have gigantic expenditures to keep training new models, and some people think their revenues so far are relatively modest. So in order for OpenAI to keep going, they need to either keep raising unprecedented sums from private investors over and over again, or they eventually need to vastly increase revenue beyond levels anything close to what they have at the moment. I take it that there is actually a reasonable possibility that OpenAI will prove to be unsustainable.
I’ve heard different arguments about this. Some people say that if that happens, it could be a systemic shock to the economy—that the bursting of the AI bubble could really be the beginning of the next financial meltdown. Other people say no, that’s a problem for OpenAI, it’s a problem for some of the people who’ve invested in OpenAI—some of the sovereign wealth funds, some of the VC firms—but most likely the valuable remains of this company would be taken over by Microsoft or Google or one of the other tech giants, and it’s not going to be a systemic shock to the economy. Do you have any way of helping us think more intelligently through what the consequences of a bursting of the AI bubble might be?
Velasco: Two thoughts on that. The first one is that I wouldn’t focus on a particular company because if in fact AI is not as productive as some people are claiming it will be, that will not affect one company. It’ll affect all of them. So, my first point is that if you look at the seven big tech companies, they account for a humongous share of the valuation of the American stock market.
Mounk: And since the U.S. stock market is a majority of the valuation of all of the world’s stock markets, it means that they’re a humongous share of the world economy.
Velasco: What’s happened in the last three or four years—it’s changed slightly in the last month or two, but let’s take the trend over the last five years—is that two things have changed. First, tech is a much larger share of the U.S. stock market, and second, the U.S. stock market is a much larger share of the world. So we’re all more exposed to American risk.
Now, that’s the financial picture, but let’s go to the core question, which is a very hard one: how large will the productivity increase linked to AI be? I don’t know the answer to that, but we can look at history. When big revolutions in technology happened—think of the arrival of electricity and the electrification of factories a century ago, or think about the arrival of the personal computer and the internet 30, 35 years ago—the gains eventually arrived, but we know two things. It took companies a long time to figure out how to use these technologies, and as a result of that, the productivity numbers took a decade sometimes to reflect the technological innovations.
I’m sure you’ve heard the quip by a famous American economist who said computers are everywhere, but not in the productivity statistics. When the personal computer arrived, we all had it, we all used it, we were all thrilled—but it wasn’t showing up in the numbers. So my guess is that AI will show up in the numbers, but it’s not going to be tomorrow. We don’t quite know which companies will use it in which way, and where the productivity gains will pop up. So anything that we do today is based on the belief—but at this point it is no more than a belief—that it’s going to be big. Big when, big where, how soon? The honest answer is nobody can be sure.
Mounk: Help me think more broadly about how much of a turning point in economic history this juncture is. There has started to be a consensus—we’ll see whether that turns out to be right—that we are at a turning point in the political order. The actions of Donald Trump as president, along with a number of other developments that have been happening over the last years, really mark the end of what we want to call the international liberal order, or whatever it was. The world is much less predictable. A lot of the rules that seemed to govern the international sphere no longer hold. We can no longer be sure that NATO is an effective organization that can provide deterrence to enemies of Western Europe and North America. The survival of the transatlantic relationship is in many ways in doubt.
On the economic front, you could make a parallel argument. The United States—one of the architects of the World Trade Organization and of the growth of free trade over the last decades—has now put up enormous tariffs, at least until a recent Supreme Court ruling, which is complicating that question. Somehow the country that is the wealthiest large country in the world, whose companies represented something like 60% of the world stock market valuation, seems to have decided that all of this order is not in its interest and is tearing key parts of it down. You could proclaim the end of globalization, as some people have. At the same time, we see that other countries are rallying to sustain free trade as best they can. Global trade has not declined significantly over the last years, and parts of the economic order are clearly proving resilient to the attacks that Donald Trump is making on them.
It’s an impossible question to answer, of course, but when people write the economic history of the 20th and 21st centuries, is what we’re living through going to be an interesting little chapter, a sort of fascinating side note, or is it going to be a major turning point?
Velasco: First, on globalization: globalization is not going away, and I think it is not going to go away for one very simple reason—because in much of the world, working-class people can walk into a supermarket and get themselves a pair of sneakers, or trainers, call them what you wish depending on your side of the Atlantic, for $10, when a generation ago the same pair of sneakers cost $30 or $40. The benefits to the average consumer in any country—whether in Asia, Latin America, or Europe—are tremendous. I don’t think any politician is going to drive us away from that. You pointed this out in passing, but I want to underscore it: in spite of all the crazy stuff being done by the United States, and in spite of the fact that China doesn’t always play a constructive role either, world trade has not shrunk. There’s a recent report by McKinsey that shows that American exports are up, Chinese exports are up, and trade among countries in the rest of the world without China and the United States is also up. So globalization is not going away—globalization is morphing and changing. You’re getting more trade among countries that are politically similar and less trade among countries that are political rivals, like China and the United States. Is this good or bad? I think in many dimensions it is bad, but globalization is not ending.
Now, what is changing? Every period of history and every international economic arrangement needs an anchor country. Shopping malls have an anchor store, an anchor department store. The post-1945 world economic order has had the United States as the anchor country—not only because the United States was large and rich, but because the United States stood for a set of rules and helped enforce those rules, and also because the United States provided something very important: a financial system and the U.S. dollar. What I think is true, even if globalization is not ending, is that the set of rules has been rubbished and is not going to come back anytime soon, and that those financial arrangements are not disappearing, but are clearly under attack.
I’ll give you one example. In every crisis that I have ever seen in my lifetime as an economist, whenever people got scared, the dollar rose. The old joke is that an emerging country currency is one from which you cannot emerge in an emergency—and when you try to emerge in an emergency, what do you do? You buy U.S. dollars. The one moment when this rule was broken was Liberation Day, almost exactly a year ago, when the United States said we’re going to increase tariffs. The standard textbook says an increase in U.S. tariffs should cause the dollar to strengthen, and instead the dollar weakened. Why is that? Because people in Beijing and in Johannesburg and in Brasilia said the Americans have gone crazy, and therefore the United States is no longer an anchor of stability.
The dollar is not going to be dethroned as the world’s reigning currency simply because there are not that many alternatives. China is a much bigger country, but I don’t think you are about to put all of your life savings into Chinese RMB. China does not have a liquid capital market, and more importantly, China does not have a trustworthy judicial system—if you ever end up in a fight, you’re not going to go to a Chinese judge to settle it. As a result, China does not provide an alternative, but increasingly other currencies—like the Canadian dollar, the Australian dollar, the Swiss franc—are stepping into the breach. The big question is whether the euro will really step into the breach. I live in the UK, not in continental Europe, but I keep thinking this is a moment for the euro to really leave adolescence and come into adulthood. But this requires the European Union to really want that. There are a number of reforms that you need—you need to make the euro more readily tradeable, you need to have a very liquid market in European bonds, not in German bonds or Italian bonds or French bonds, but European bonds. That can be done. It’s not that difficult to imagine a world in which the euro rivals the dollar—not tomorrow, but in five or ten years’ time. But this will require political will.
Last but not least, there’s the security issue. NATO was mentioned earlier. Kyiv is what—two hours away by plane from Berlin? So this is not an imaginary threat. It’s a very real threat that is very close. From a security point of view, for people living in Europe, the world is very, very different. A massive question is whether Europe will get its act together when it comes to defense and really become autonomous from a security point of view. Europe is not autonomous from a security point of view today, but it needs to be.
Mounk: Let me dig a little bit deeper into this question of a reserve currency. The first general question to ask is: what are the advantages and disadvantages of effectively being the world’s reserve currency? I think that’s part of a political debate in the United States. Obviously, one of the advantages is that it makes it much easier to issue debt and it means that you can borrow at much lower cost—those are significant advantages. Is there a disadvantage, especially when you’re talking about smaller countries like Canada or Switzerland partially stepping into the role of reserve currency? Are they appreciating the local currency in ways that can have negative consequences for citizens of those countries? Or am I making a wrong economic assumption here?
Velasco: Let’s start with the United States, because today in the United States there are many people—mostly linked to the Trump administration—who claim, erroneously in my view, that the United States pays for being the world’s reserve currency. That makes absolutely no sense. Money is a bunch of pieces of paper that cost nothing to produce. There’s an amazing fact that the world wants to hold these little pieces of paper that cost nothing to produce. So the United States collects a tax on the rest of the world. It’s not an explicit tax—it’s not legislated or mandated anywhere—but every time I take a green piece of paper in exchange for a good that I made, I am giving the United States a break. That’s one big advantage.
The second big advantage is that the United States borrows massively internationally in its own currency, and whenever things get tougher in the United States, the dollar depreciates and therefore the real value of the outstanding debt goes down and Americans get a benefit. That happened, for instance, after World War II, and it happened during the Vietnam War. At points of stress when the U.S. economy is in trouble, the dollar depreciates, and therefore if I’m holding American debt, I—as a resident of Europe or as a resident of Asia—lose.
So this is really a pretty win-win situation for the United States. Some people say this means that the dollar is too strong. First of all, it’s not clear what it means for the dollar to be too strong. And if that is a problem, there are ways of dealing with it. One reason why the dollar has been strong is maybe that the United States has a fiscal policy that doesn’t make a lot of sense, and the United States could correct that. But bottom line, the idea that the world is ripping off America because we all hold dollars makes absolutely no sense. That’s simply MAGA nonsense.
Mounk: What about smaller countries? Part of this is that the United States is such a big country and such a big economy that people from around the world wanting to hold U.S. dollars may not have as big a distorting impact on the currency. If the whole world suddenly flooded into Canadian dollars, presumably that would make a much bigger difference to the valuation of that currency. Could that distort things in ways that would actually be a problem for the Canadian economy, or is that not a serious concern either?
Velasco: Yes, maybe, but let me qualify it in ways that are important. Most countries, in fact, worry about the opposite problem—most countries worry that they issue currency and nobody wants to hold it. So having the rest of the world want to hold your own currency is 99% of the time a great thing. Why does a country like Argentina often get into trouble? Because nobody wants to hold the Argentine currency, not even Argentines. So when people say they want to hold Swiss francs or Canadian dollars, the first line of argument must be: what a great thing.
Now, there is a danger in what economists call sudden surges of capital inflow. It could well happen that interest rates in the United States are suddenly low and people are looking for some other place to park their money. A lot of money comes into your country and all of a sudden your currency appreciates. You can find episodes in history—not only in Canada or in Switzerland, but even in emerging markets—where people are getting out of the United States because interest rates are too low and they come to your country and appreciate the currency. That can be a problem. But it’s a nice problem to have. It means that people trust your currency and trust your country. There are also tools for dealing with it—you can cut your own interest rates, or you can impose some disincentives to capital inflows. Countries have done that; countries have taxed capital inflows. So if that is a problem, you can deal with it. But believe me, 99% of the time, it’s a problem you really want to have.
The more serious problem is the opposite: people dump your currency, people don’t want your currency. That’s bad for your currency, for inflation, for domestic residents. That’s not the problem of Canada today, Australia today, or Switzerland today.
Mounk: Let’s get to the book that you’ve just published, which is really interesting. It’s called The London Consensus. That, of course, is a play on The Washington Consensus. What was the Washington Consensus? What’s wrong with it and why do we need to supplant it?
Velasco: The Washington Consensus was a set of ideas that emerged—predictably—out of Washington around 1989, 1990. There was a conference at a place called the Institute for International Economics, which is still around under a slightly different name. A big fat book came out edited by a man called John Williamson, a British economist living in Washington. It became a bit of a blueprint for a certain kind of economics. Some people like to call it neoliberal. I don’t particularly like that label, because neoliberal has become really a bit of an insult.
Mounk: It’s not just that it’s an evaluative term—there are many evaluative terms that are fine. I think “fascist” is in my mind an evaluative term. I think that anything that is rightly called fascist is bad; it does, even though it’s often overused, have a core meaning that actually makes sense. The problem to me with how people use “neoliberal” is that it’s just a way of saying, it’s something I don’t like, and beyond that, I don’t think there’s a clear meaning.
Velasco: When you say “fascism,” you’re thinking of concentration camps. But when you say “neoliberal,” it’s not clear what you’re talking about. So let us go back in history. The conference was held in Washington. The book was presumably about the world, not about Washington, but it was mostly in response to the Latin American debt and financial crisis, which mattered to the United States at the time because the people holding that debt were American banks. People around Washington were wondering: what’s wrong, why did this happen, and what do we do to make sure it doesn’t happen again? So predictably, at a time when the problems were high debt, weak banks, high inflation, and big government deficits, the medicine was: stabilize the public finances, increase interest rates, bring down inflation, maybe shrink the government a little bit, liberalize prices.
At the same time, this happened more or less coincidentally with the collapse of the Berlin Wall and the liberalization and reform of countries in Eastern Europe and the former Soviet Union. There, obviously, the problem was too many controls, a state that was too large, and in some countries like Poland, high inflation and high debt. So the solution was the obvious one. People like Ronald Reagan and Margaret Thatcher, of course, took these ideas and applied them, and the World Bank and the IMF also took these ideas and applied them around the world. In some places, they made sense—clearly in Latin America in the 1980s, government deficits were too large, public debt was too high, and something had to be done about it. The problem was that this set of commandments—and Williamson really came up with a list of ten things to do, and it looked like the Ten Commandments—were not universally applicable. So all the criticisms about one-size-fits-all economics really were relevant. Secondly, the problems of 35 years ago are not necessarily the problems of today.
So what did we do? An LSE colleague, Tim Besley—a very influential British economist—and I and another colleague, Irene Bucelli, asked ourselves: what is it that we have learned in the last 35 years, we as in the world at large and we as in the economics profession? We invited a number of colleagues, most of whom are LSE-based or studied here or have taught here, and said: tell us, in your subfield—whether it’s international trade or finance or fiscal policy or whatever—what do we know today that we didn’t know 35 years ago, and what is it that we should do differently? Which bits of the Washington Consensus merit keeping, and which bits were completely wrong and need to be thrown out the window? Tim and I wrote an introduction which doesn’t try to summarize the book—the book is huge, it has 670 pages—but tries to extract some themes.
Let me give you two ideas broadly, and then we can dig deeper. One idea is that certain things in the Washington Consensus remain true. You want to be careful when it comes to fiscal deficits and debt, because you don’t want to end up like Argentina—you don’t want to be a country that is always teetering on the verge of collapse. It is also true, and a lot of research has shown, that international trade does bring benefits. The gains from trade—to use the phrase by David Ricardo—remain large. So overall, it is a good idea to trade. The idea that you’re going to become Cuba or North Korea, close your economy, and become prosperous makes absolutely no sense. But the gains from trade are unequally distributed, and those gains also mean that some people lose. One big mistake that we made back in the 80s and 90s is that many countries—especially the United States—did nothing, or close to nothing, to address the plight of people who lost.
Let me mention another idea. Some people say that economic growth is a bad thing, that we should embrace degrowth. We don’t think that. Certainly, if you come from a developing country, you want to grow—economic growth is important. You only hear degrowth ideas from citizens of rich countries; you don’t hear that in India or in Africa or in Brazil. People want to grow. But what we have learned is that growth is a lot more complicated than the Washington Consensus suggested. The cliché from the 1980s—the Ronald Reagan and Margaret Thatcher line—was: get the government out of my way and private businesses will get the economy to grow. We know today that many countries followed the Washington Consensus, liberalized, opened up, and didn’t grow very much.
Colleagues like Philippe Aghion—the French economist who won the Nobel Prize last year, a colleague here at the London School of Economics—have explained why. Growth is all about productivity, and productivity is all about innovation. To innovate, you need to invest, and in order to invest, you need a very delicate ecosystem in which the private sector has to do its bit, universities and researchers have to do their bit, and the government has to provide some key inputs for that research to be fruitful—because the bets are risky. Not every country has this ecosystem. The United States has one. Europe, remarkably, even though it is a rich region, doesn’t have much of one. Mexico is an example: Mexico followed the Washington Consensus to the letter and has low inflation today, but doesn’t grow very much. So we need to be less ideological about growth and think about what forms of collaboration between the government and the private sector get innovation going. That’s a very relevant debate—not just for the Mexicos of the world, but for Germany and much of Europe today.
Mounk: What I think is really interesting about this project is that you’re clearly trying to replace an old framework with a new framework—that’s implicitly, and I guess explicitly, the goal of this project. But you’re not trying to throw the baby out with the bathwater. You’re not saying that everything about that old project was wrong or that we didn’t get anything right in the last 30 years. You’re replacing a framework in a way that’s still building on some of the enduring wisdom in it.
I’d love to get an overview of where this new framework would differ, and then to dig into some of the specific points. A very simplistic summary of the Washington Consensus is that it has ten points. It wants you to have fiscal discipline; to reorder your priorities in public spending, shifting away from subsidies towards more broadly beneficial investments like education and healthcare; to reform the tax system to broaden the tax base; to liberalize interest rates; to pursue competitive exchange rates rather than protecting your currency; to liberalize trade; to make it easier for foreigners to invest in your country; to privatize state-owned enterprises that aren’t very efficient; to deregulate sectors like telecommunications that used to be highly regulated in many countries; and finally, to secure property rights, making sure that there are better legal protections for them.
I imagine that a number of these you still agree with—securing property rights, fiscal discipline, and probably some of the tax reforms—still make sense. Some of this has become a victim of its own success. It probably was right in the late 80s and early 90s for many countries to deregulate. But just as I’m skeptical of the idea of ever closer union in the context of the European Union—because it has no logical endpoint, and surely there’s a right level of closeness—the same is true about deregulation. Some deregulation was good, but perhaps in some ways we went too far, and clearly we don’t want to always keep deregulating. Some things need to be regulated.
So where do your disagreements lie? Where was this perhaps wrong all along, now that we know a little bit more? Where have we done enough of the right steps that emphasizing them today just isn’t helpful? Where do you think we really need a new departure—a completely different set of principles to guide our actions?
Velasco: This is not black and white—it’s not Washington all bad, London all good. Pessimism is fashionable, but we have to recognize that the world did certain things reasonably well over the last 30 years. I’m old enough to remember the 70s and 80s, when inflation was high pretty much everywhere. Today—leave Venezuela and a couple of other countries aside—inflation is mostly low everywhere. That’s a big achievement. There are things about the Washington Consensus that of course have to be right.
Mounk: One thing I remember is that when I was in college, the big debates about the World Trade Organization were that this is going to screw poor countries—that the World Trade Organization was just a way to exploit India and China and make sure that they stay poor forever. Today, when you hear criticisms about the World Trade Organization—including from the progressive left—it’s that they screwed over steelworkers in Michigan. That is a very real concern, as we were talking about the inability to compensate some of the losers. We had David Autor on the podcast recently, who spoke about this—and that’s a serious topic. But it’s very different from what people were saying back when I was in college, which was that this is going to screw over those countries that have actually grown enormously over the last 25 years, significantly reducing poverty in them.
Velasco: The paper that we have in the volume makes exactly that point—that the benefits from free trade today, we know how to measure them better than we did before, and they’re humongous. You’re making a very interesting political point, which I agree with and not many people make, so I want to underscore it here. Because free trade has become controversial in the American Midwest or in the north of England, many people jump to the conclusion that free trade today is controversial everywhere. That is not true. The people calling for a more closed economy are not in India, not in South Africa, not in Nigeria, not in Turkey, not in Brazil—not in the emerging or developing world. They’re mostly in the United States and the UK and bits of Europe. So the idea that free trade is bad for the poor is one idea that simply did not resist the test of time.
Of course, when you liberalize—I said it already, but I want to repeat it—there are winners and losers and you need to address that. But a more open economy, Ricardo could have told you this a couple of centuries ago, is going to be good for the people making products that you can export. If you’re a farmer in Africa or a farmer in Latin America who couldn’t export that product before and now can, you are going to be better off. We’ve seen a lot of that. The last 35 years brought hundreds of millions out of poverty in India and China, and that’s a massive increase in human well-being.
So that’s the past. Let’s now move to the present. Where do we think that the Washington Consensus got it wrong? Let me mention two or three areas. One is that precisely in having that set of ten commandments, it oversimplified reality and sometimes provided the wrong medicine. Yes, privatization is justified much of the time, but it is not justified all the time. For instance, we learned during the world financial crisis that having state banks can be a stabilizing force, because state banks can do the things that private banks don’t do in the middle of a panic. Yes, deregulation of many over-regulated industries was probably called for in the 1970s, but having a well-regulated financial sector is absolutely crucial—and if you don’t have a well-regulated financial sector, you’re going to have crises like the one the world had 15, 20 years ago. The Ten Commandment approach—do this regardless of who you are, where you are in the world, what your level of development is—that’s bad economics, period.
The second thing where I think the Washington Consensus got it wrong is that it misunderstood the sources of human well-being and human frustration, because it said what really matters is financial payoffs. If there are no jobs in your town or in your province or in your part of the world, just move elsewhere. What we have learned in the last 35 years is that when people leave places like the American Midwest or the North of England or bits of Spain or bits of India, what is left behind are regions that go into a tailspin of decay—crime sets in, deaths of despair set in. Politically, these are the people who end up voting for Trump or voting for Brexit. We know today something we should have known all along: that people care about their paycheck, but people also care about belonging to a community that feels respected, and about identifying with a group that is felt to be respected. We care about belonging and we care about the wellbeing of the people around us. In our rush to decentralize and open up and deregulate, we forgot that. We paid a price economically, and we paid a huge price politically—because this is one of the sources, not the only source, of populism and rising authoritarianism around the world.
The Washington Consensus also got growth wrong. Growth is not simply about getting the government out of the way. Yes, government can sometimes overdo it, but government needs to provide many very crucial inputs. I’ll give you a concrete example from my own experience. I was the finance minister of Chile when Chile signed a trade deal with the European Union, which is still in force today. Part of Chile is in Patagonia, and Patagonia has a lot of sheep, so people were very happy because they could export mutton to the European Union. What did Chilean farmers who produce mutton learn very quickly? That their mutton was very high quality, but before you could export to the European Union, you needed slaughterhouses that were up to European Union standards. You had to guarantee that the animals had not been given medicines outside European codes, and that the transport was safe so that the meat would arrive in Europe without spoiling. Who provides those guarantees? Who certifies the quality of the vaccines that the animals are given? Who certifies that the slaughterhouse is up to a certain standard? Who provides the roads and the ports and the airports through which that product gets exported? That’s the government. So if you don’t have a state that is working with the private sector to identify those needs and those regulatory structures, you’re not going to export anything.
Countries that really had an exporting revolution—think of Ireland in the last generation, think of Singapore, think of Uruguay—these are countries with able states. Which takes me to my last point. Because the Washington Consensus felt that the state really has to be gotten out of the way, it forgot that a capable state is at the root of everything. You don’t have a thriving financial sector like the City of London—four blocks away from where I am—unless you have the best regulation in the world. You don’t invest in a market that is not well regulated; you’re going to lose your shirt. You don’t invest in a country where the judicial system is not up to par, because they’re going to steal your money and you can’t get it back.
Let me give you an example from the pandemic. Many countries spent a lot of money on vaccines and people died—there were hundreds of thousands of deaths because they didn’t have the state capacity to reach the last town in their territory and vaccinate the last person who needed it. This is not rich versus poor. In Latin America, some countries vaccinated everybody very quickly because they had the state capacity to do so—because they have been vaccinating people for the last 50 years. The country next door, perhaps a richer country, didn’t have that state capacity, and people died as a result. So it is not that we want to go back to the 1950s and argue big state against small state—this is not Thatcher against Marx. The question is: how do we get states to be able to do the things that states need to do? Guarantee private property, regulate finance, build good infrastructure, get people vaccinated before a pandemic. That requires a certain kind of policy and a certain kind of attention that the Washington Consensus entirely missed.
In the rest of this conversation, Yascha and Andrés discuss the policy implications of the London Consensus and what artificial intelligence will mean for the economy. This part of the conversation is reserved for paying subscribers…
