Joe Biden has made restoring America to its pre-Trump normalcy the animating force of his campaign and presidency. One of the planks at the core of his agenda is the promise to get the proverbial band of highly developed democratic nations back together. 

America’s relations with its traditional 20th-century allies in Europe had suffered following Trump’s blustery go-it-alone foreign policy and decades of unease over issues like the Iraq War and the 2008 financial crisis. Biden would get back on board with internationalist priorities like meeting the climate crisis, increasing energy security, repairing supply chains fractured by Covid, and strengthening defense ties between democracies. 

National Security Adviser Jake Sullivan crystalized the administration’s thinking in a speech this spring at the Brookings Institution, dubbing the investment-heavy approach a “new Washington consensus.”

Yet something happened on the way to Biden’s restoration of America’s pre-Trump internationalism: Many of the US’s allies like Japan, Canada, and especially the European Union have not been all-in. They see the Biden administration’s signature accomplishments — such as the Inflation Reduction Act (IRA) — less as long-awaited efforts to finally make good on promises of climate action and more as a threat to the ability of places like Europe to attract investment themselves. 

At the moment Biden wanted the transatlantic democratic alliance to come together for a common purpose and approach, wonks on either side of the ocean are sniping at each other. 

The brewing row between longtime allies is “mutually assured sanctimoniousness,” says macroeconomics commentator and self-described “globalization defender” Karthik Sankaran. 

After decades of pleading with America to finally take action on issues such as climate, why are our closest partners so annoyed at us now that we’re actually doing what they asked? 

The Biden administration’s “new Washington consensus” flies in the face of the market orthodoxy of the old “Washington Consensus” — something that was perhaps stronger in Europe than it ever was in America. European political and economic institutions aren’t set up to foster national investment booms and tech drives. In fact, the continent’s supranational governing structures were set up to restrain member countries from exactly the kind of national one-upmanship in which Biden and his team are cajoling allies to engage. 

The family feud within the Atlantic alliance shows that debates over how to implement a green transition are also about negotiating the global balance of economic power. In an era of more openly competitive international economic relations, obeying the rules in the European mold risks getting left behind, but playing to unique advantages as Biden wants America to do risks alienating allies. Even though Biden’s administration has promised to use green investment to create a “new consensus” domestically and internationally, it’s not yet clear many strategic partners are willing or indeed able to follow suit. 

The rise of the old Washington Consensus, explained

“Washington Consensus” is one of those jargony terms like “neoliberalism” or “polycrisis” that gets tossed around a lot by academics and wags on the international conference circuit. Unlike those other buzzwords, though, the Washington Consensus refers to a very specific thing: a set of 10 policy principles for economic development first enumerated in 1989 by economist John Williamson. 

The 10 bullet points of Williamson’s Washington Consensus will sound familiar to any student of a mainstream Econ 101 class: 

• Keep government spending and fiscal deficits in check
• Avoid subsidizing or protecting local industry to focus on health and education
• Moderate taxes
• Let the market set interest rates
• Keep exchange rates steady through independent monetary policy
• Allow free trade
• Encourage foreign direct investment from private sources of capital
• Privatize publicly owned assets
• Deregulate the economy as much as possible
• And ensure rock-solid private property rights.

The principles were initially supposed to be guides for newly industrializing and developing markets, and were pioneered in places such as Latin America by local experts and bureaucrats, rather than in DC itself. 

From the 1980s to the 2000s the Washington Consensus came to be more or less unquestioned economic common sense both in many peripheral developing nations and within the United States and Europe. 

At the height of the Washington Consensus’s prestige, ostensibly left-leaning elected officials such as Bill Clinton in America and Tony Blair in Britain eagerly sold off public assets, encouraged the ever-freer flow of capital and goods across borders, and generally deferred to market actors when shaping the economy. Leaders who tried to turn the policy tide back toward more direct state intervention, like Francois Mitterrand, France’s Socialist Party president through the 1980s and first half of the 1990s, were swiftly disciplined by market forces and reversed course. 

At an international level, the old consensus was enforced by bodies like the International Monetary Fund, which made compliance with the principles a condition of financial aid to struggling countries, and the World Trade Organization, which resolved trade disputes and penalized countries whose governments tried to give domestic firms extra boosts. 

The European Union, created by the 1993 Maastricht Treaty, was a product of the era of the Washington Consensus. The EU was the fruit of decades of effort after World War II to bind together European economies (and especially perennial continental antagonists Germany and France) through ever-freer and denser trade connections, while cooling down national competition that for centuries had routinely escalated into cataclysmic war. 

Notably, the EU constrained member states’ fiscal policy to prevent local governments from trying to give their firms a leg up over competitors elsewhere in the EU, restricted deficit spending, forbade the issuing of common government debt, and — with the launch of the Euro — totally eliminated Eurozone members’ ability to manage their currency as a means of boosting exports.

The fall of the Washington Consensus

But by the end of the 21st century’s first decade, the Washington Consensus appeared to be badly faltering. 

Many of the Latin American countries that first adopted the Consensus’s policy portfolio saw massive disruption but not necessarily great economic outcomes. Increased free trade provided much cheaper consumer goods, but at the cost of good manufacturing jobs in old industrial core regions like the Upper Midwest that were outsourced to lower-wage countries. In Washington itself, the George W. Bush administration dispensed with deficit reduction in favor of massive tax cuts and a huge increase in military spending. 

Crucially, the country with the most successful economy of the 21st century — China — largely threw Washington Consensus policies out the window. Even as China joined international bodies such as the World Trade Organization that were supposed to enforce Washington Consensus rules, China did not really abide by those rules: It subsidized key industries and protected domestic firms from foreign competition. 

Not only did China succeed in the world trading system without playing by its rules, it also successfully resisted the pull toward political liberalization and closer strategic alignment with a hegemonic United States that free trade and economic growth were supposed to facilitate. As Chinese demand surged, it became a geopolitical rival for influence in crucial commodity-producing regions of the world like the Middle East and South America. 

Moreover, once-developing smaller nations such as South Korea and Taiwan leap-frogged to the top of the global value chain in areas including semiconductor manufacturing, shipbuilding, and even entertainment through intensive industrial policy — subsidies, coordination, and active government planning in certain sectors deemed strategically important. These countries’ historic success undermined the Washington Consensus dogma that industrial policy was a mistake.

At least in the immediate aftermath of the 2008 financial crisis, economic policymakers in the United States in both parties largely eschewed Washington Consensus recommendations: They approved the biggest fiscal stimulus in American history up to that point, used extraordinary central bank measures to hold interest rates close to zero and intervene in capital markets, and bailed out the privileged American auto industry.

But in many ways, Europe stuck to the script. When the 2008 financial crisis spread to countries in the European periphery like Spain, Italy, Greece, Hungary, and Latvia, the EU imposed punishing Washington Consensus style reforms on some of the most recent additions to the union: Instead of offering stimulus, the EU compelled austerity, far beyond what the IMF itself recommended. Some scholars called this the “EU rescue of the Washington Consensus.” 

The results were abysmal. Europe emerged from the 2008 crisis poorer than the US, with much slower growth. Austerity badly damaged popular trust in the European Union. Peripheral countries like Latvia and Estonia saw some of the worst levels of unemployment in the world, leading to massive levels of emigration that arguably contributed to the rise of far-right xenophobic and EU-skeptical politics around the continent. 

European “core” economies such as Germany couldn’t count on selling to stagnant peripheral nations in the Union and became increasingly dependent on demand from China as an export market for high-value-add manufactured goods like cars or machine tools. That’s a decision that now looks risky as China’s state-incubated electric vehicle industry has emerged as an export powerhouse in its own right, threatening to capture the international and possibly even domestic market that European national champions like Volkswagen had assumed would be theirs.

The EU could have a hard time making the turn from old to new consensus

Biden and his supply-side progressives draw a direct line from the austerity of Washington Consensus policies to the rise of the far-right nativist politics and international tension. The administration broke with economic orthodoxy and passed interventionist measures like the IRA to restore political calm.

When Jake Sullivan laid out his vision of a new Washington consensus for the world, based on legislation such as the IRA and CHIPS Act, with ample industrial subsidies, he said these policies would provide the foundation for a “fairer, more durable economic order.” 

In contrast to the height of the old Washington Consensus years when DC-aligned development institutions preached the neoclassical economic gospel to restrain local industrial development efforts, Sullivan and other senior Biden administration officials have invited their allies to put serious effort into boosting their own local green manufacturing sectors.

But many in Europe are still pretty attached to the old way of doing economic policy, and feel threatened by Biden and company’s cajoling. Emmanuel Macron called the IRA “super aggressive” last year. The Europeans have good reason to take issue with Americans informing them that they have to change their entire approach to economics and trade: after all, the EU’s economy is much more enmeshed in global trade than America’s, with the continent’s exports accounting for half its GDP compared to just 11 percent of America’s GDP.  Europeans can’t afford to be so cavalier about changing up the program, as painful as their recent economic experience has been.

The IRA does a number of things that would be difficult for Europe to stomach. While the EU has pursued carbon pricing for decades to penalize emissions, Biden’s bill takes an “all carrot, no sticks” approach to inducing green investment through open-ended tax credits rather than penalties on polluting behavior: Tim Sahay of the Green New Deal Network, one of the leading advocates informing the IRA’s drafting, has compared the bill to a “bottomless mimosas” brunch special. 

While the EU’s climate trade policy, the Carbon Border Adjustment Mechanism, at least in theory would not privilege domestic products over imports from countries with equally muscular emission reduction policies, the IRA is nakedly protectionist. Its Buy American provisions are aimed more at jumpstarting a green energy and electric vehicle sector within the US than completing a green transition as quickly as possible with cheap imported components from existing firms in Europe or Asia. The IRA’s generosity rests on America’s uniquely enormous fiscal power as the issuer of the world’s most important reserve asset, the US Treasury; whereas Europe has been loath to issue common bonds beyond a Covid one-off. 

The bill also follows in the long federal tradition of transferring money and resources from high-income areas to low-income ones with few strings attached, whereas attempts to do so in Europe are much more fraught: The post-2008 bailout of Greece nearly tore the Union apart as rich nations balked at helping their poorer fellow EU members, and the strings that come with more routine funds for newer members like Poland and Hungary have become tripwires for debates over rule of law and local autonomy. 

Many in the EU fear that the European Union lacks the legal ability to offer incentives to firms as sweet or geographically focused as the IRA or CHIPS Act, and they believe firms will cancel European investments to instead put new facilities in North America. Indeed, these fears may be playing out already: Volkswagen recently paused planned battery factories in Eastern Europe for lack of subsidies. (It eventually settled on a Canadian location after receiving even more generous subsidies than the IRA affords.) Americans often complain about gridlock in Congress stalling most meaningful legislation, but the European Union would have to revise its basic founding treaties to enact policy that matches the firehose of money unleashed by the IRA, an even more difficult process. 

Policies like the IRA aren’t settling arguments among allies as much as they are provoking them. But Europe cannot wish its way back to a pre-2008 reality of unquestioned faith in economic orthodoxy and globalization, either. So even as Biden and his advisers seek to forge a “new Washington consensus,” the actual agreement at the heart of said consensus can be hard to see right now. 

As inflation persists at multi-decade highs, the pressure is on the Federal Reserve, above all other economic policymaking institutions, to halt rising prices: The central bank announced another interest rate increase Wednesday in its ongoing efforts to combat inflation.

Since the climax of the last major inflation crisis in the 1970s, independent central bank chiefs willing to administer proverbial harsh medicine — raising interest rates so high they potentially cause a recession — have reigned like near-deities over our economic lives.

In this, Fed Chair Jerome Powell stands in the shadow of his most legendary predecessor, the late Paul Volcker. Inflation hawks want Powell to go “full Volcker”: follow the elder banker’s example from 1979 and raise interest rates high enough to choke off demand, even at the cost of a devastating recession. 

The Volcker shock looms large in the mythology of central banking: the moment when neoliberal Zeus slew the old economic Titans standing in the way of progress. Volcker’s rate hikes sent the US economy into the worst recession since the Great Depression during the early 1980s, but it eventually recovered into what’s called the “Great Moderation”: a more than three-decade stretch when inflation seemed banished even as economic growth returned. 

Powell’s Fed has raised interest rates throughout 2022, and looks like it wants to channel Volcker, at least in spirit. But this “great man” story of inflation-fighting that gives the credit for stable prices to technocratic central bankers fiddling with interest rates leaves out a good deal of context that explains not only why inflation cratered, but why it stayed down.

Central bankers can engineer a sudden shortage of credit, but they can’t necessarily address knottier distributional questions, like whether workers should have the legal means to demand higher wages. Nor can they build the systems and infrastructure that increase productivity and access to cheap stuff, which are the product of decades of investment and coordination. 

In other words: The monetary tightening inaugurated by Volcker was one part of an entire deflationary policy repertoire that also included union-busting and the creation of a global supply chain to hold down the costs of labor, components, and commodities.

Neither of those options outside the realm of monetary policy is really available right now. While wages have risen, unions aren’t the real force pushing up pay anymore. And the global supply chain that gave us cheap imports from anywhere in the world is part of the problem: It’s currently breaking down. The Fed might be able to choke off credit to slow investment and job creation, but it can’t create the real-world political, legal, and logistical systems that in the past have kept prices down even amid economic growth.

To truly tame prices, we can’t just turn off the money hose. We have to plan for more concrete long-term solutions to a lack of labor, commodities, and goods. 

How union-busting helped defeat inflation

The Fed has one main knob to turn to raise or lower the economy’s temperature: interest rates. When the Fed raises the cost of borrowing money from the central bank, the rest of the financial system that ultimately provides credit to businesses and households raises its rates in turn, reducing the amount of money available to open new businesses, finance big new projects, or buy homes. This is supposed to lead to fewer jobs, slimmer household budgets, and less confident workers making fewer demands of their bosses, slowing down spending and wage growth.

The relationship between inflation and employment is described in the famous 1958 economic theory known as the Phillips curve, which states that inflation rises as unemployment falls.

The conundrum described by the Phillips curve — that more jobs mean higher prices — was at the heart of conversations about pre-Volcker inflation: It appeared that after the  unprecedented boom of the 1950s and 1960s, when large numbers of American employees first achieved middle-class standards of living, we consumed more than could be efficiently produced and, for instance, became more reliant on imported oil.  

As prices for gas to fill boat-size cars soared, workers asked for raises, compelling their bosses to raise prices to pay those high wages, which put pressure on their customers to demand raises from their bosses in turn — what’s known as a wage-price spiral. All the while, supposedly feckless central bankers avoided sharp interest rate hikes that might have cut off demand, trying to please politicians riding high on the birth of mass affluence. No one had the nerve to stop the cycle.

In the heroic model of central banking, Volcker and his successors like Alan Greenspan stopped the vicious wage-price cycle not only by raising rates, but by establishing the central bank’s “credibility” that the institution was independent from elected officials. That is, investors, employers, and workers could now credibly expect the central bank to raise interest rates if the economy got too hot, and would temper their wage and price setting accordingly. When expectations about future inflation are grounded by the sense that the Fed will intervene before prices spiral out of control, economic actors are supposed to have confidence that their assets will retain value, so they’ll feel safe investing or hiring.

Confidence in central bank independence allowed for the “Great Moderation” of the late 1980s through the 2000s, where growth continued — albeit much more slowly than during the post-WWII years — and unemployment fell without sparking inflation.

It’s a very elegant schematic of balanced forces and rational actors. But it leaves out the messier side of the deflationary story of the late 20th century.

The wage-price spiral might have been broken in the 1980s by less savory means. As senior Fed economists David Ratner and Jae Sim wrote in a paper earlier this year, the wage-taming owed a lot to nitty-gritty union busting and labor policy that makes it harder to organize and collectively bargain. 

In other words, they write, inflation may arise not from “too much money chasing too few goods,” as mainstream economists typically argue, but as a side effect of class conflict. Without strong unions, workers are less able to demand higher wages even as labor demand grows, flattening the Phillips curve. Ratner and Sim’s analysis found that loss of worker bargaining power reduced inflation volatility by 87 percent even without monetary interventions like interest rate hikes.

Volcker’s shock and central bank independence happened at the same time as Ronald Reagan’s anti-union effort; the emergence of New Democrats like Jimmy Carter and Bill Clinton, who were less sympathetic to organized labor than their New Deal and Great Society forebears; and the collapse of union membership across almost every sector of the economy except government. Volcker and his central banker colleagues were keenly aware of the importance of union power to increasing wages: The minutes of Fed meetings show that these policymakers fixated on the ability of unions to set wages even after many academic economists had moved on from the subject.

Unions may be notching some wins right now, but the national unionization rate is half what it was in 1983, when the Bureau of Labor Statistics started tracking the metric. Today, rather than pushing for higher wages, unions may in fact be suppressing them: By negotiating long-term contracts, they lock in pay for their members for years at a time, regardless of what happens to price levels. Pay increases are instead driven by a wave of retirements that were likely inevitable at some point in the near future, new labor market opportunities created by remote work, and a massive number of quits in difficult, typically lo- paying jobs in health care, retail, and food service. And for all the labor market chaos, wages haven’t driven inflation, instead lagging behind the cost of living. So it doesn’t appear the calls for Powell to go full Volcker would actually solve current causes of rising prices. If we want growth without inflation, we have to find new sources of labor, energy, and stuff.

The supply chain frontier has closed

Just as Volcker’s rate hikes coincided with a bipartisan anti-union push, so the rise of central banks paralleled the acceleration of globalization and the creation of a world-spanning super-efficient “just in time” supply chain. New logistics infrastructure, trade deals, and methods of inventory management allowed firms to get cheap commodities and components from the other side of the world astonishingly quickly. Globalization also reinforced the attack on unions, since it allowed businesses to move factories to countries with weaker labor laws, humbling labor leaders of industrialized economies. After the 1980s, and especially after the fall of the Soviet Union, markets began to integrate many formerly communist countries with large, well-educated — but poorly paid — workforces and ample natural resources. The creation of global supply chains depended in large part on a relatively calm geopolitical scene, with no serious confrontations between “great powers,” who generally seemed to be on the same page regarding globalization.

The globalized world of fast free trade was supposed to take the sting out of the demise of labor’s bargaining power. Sure, workers couldn’t improve their working conditions or pay. But if the stuff their wages bought got cheaper, economists reasoned, they would have less need to demand higher pay in the first place. As some post-Keynesian economists have argued, inflation moderated when globalization increased imports and labor competition, not because investors had “anchored expectations” about central bank policy. 

It’s this model of globalization that is currently breaking down, leading to volatile rising prices. As anyone who has ordered a piece of furniture in the last two years can tell you, “just in time” has become a thing of the past. Instead of speedy manufacturing getting imported from any nation on earth, now we import their supply chain bottlenecks, as, say, plumbing component manufacturers in China hamstrung by that country’s “zero-Covid” policy hold up house completions in the United States.

While supply chain bottlenecks were widely predicted to ease in 2022, geopolitics got in the way. The Russian invasion of Ukraine and subsequent economic retaliation rocked global energy supplies, a particularly troubling economic disruption since energy is a vital component of nearly every product, and further poisoned relations between wealthy Western countries and Russia’s key ally, China, where so much of the stuff Americans buy is made. Instead of getting more cheap electronics from China, the world’s second-largest economy, the US is sanctioning the chip industry there.

If the Federal Reserve is largely removed from the internal dynamics of the labor market, it has even less to do with foreign policy and geo-strategic maneuvering. 

Policymakers risk fighting the last war

The Federal Reserve is several months into its most aggressive rate-hiking cycle since Volcker’s famous shock, and inflation has not subsided. Even as higher rates choked off home sales and slowed job growth, September saw annualized inflation of 8.2 percent. The Fed’s higher rates seem to be imposing the expected economic pain, but with little deflationary pay-off.

Instead, what little relief Americans have enjoyed has come from unconventional direct interventions in the real economy, like the Biden administration’s release of oil from America’s Strategic Petroleum Reserve during the spring and summer. A July Treasury analysis suggested the SPR release, with similar international actions, lowered gas prices by 17 to 24 cents per gallon.

It seems that the lessons of the Volcker era do not necessarily apply to 2022. Though our own era is dominated by rising prices and highly politicized conflicts over energy, just like the 1970s, the particulars of our current inflationary dynamics appear quite different. So it’s natural to wonder if the same policy tools will necessarily work to slow rising prices.

We don’t want policymakers to make the mistake of fighting the last war. If we leave inflation up to the central bankers rather than continuing the push for coordinated investments in cost-saving renewable energy and dense housing, or policies that reverse the shrinkage of the labor supply since the pandemic, we won’t so much beat inflation as resign ourselves to a poorer, less resilient future.

Update, 3:45 pm: This story has been updated to include the Fed’s latest rate increase.