Home .Governing globalization Government is back!
Government is back!
Friday, 04 September 2009 09:56

Government goes in and out of fashion.  For much of the past two decades, government was out of fashion.


Indeed, former US President Ronald Reagan made some of his best jokes about the role of government:

. “Government is like a baby. An alimentary canal with a big appetite at one end and no responsibility at the other.”

. “I'm convinced that today the majority of Americans want what those first Americans wanted: A better life for themselves and their children; a minimum of government authority.”

. “In this present crisis, government is not the solution to our problem; government is the problem.”


But after the 9/11 terrorist attacks, most realized that we need government to protect our security.  And right now with the global financial crisis, government has had to come to the rescue and bail out the private sector, which messed up royally!


In reality, government does have an important role to play in the development of our economies and societies, in rich and poor countries alike.  Development without an effective state is impossible.  But in situations where government is incompetent or corrupt, we are better off without governmental intervention.  Government failure can be worse than market failure.  The key thing is governmental effectiveness.  An effective state (with the ability to undertake and promote collective action efficiently) is vital for the provision of the goods and services – and the rules and institutions – that allow markets to flourish and people to lead healthier, happier lives.  Some 12 years ago, the World Bank published an excellent book on the state in a changing world.  In this article, we will review its main conclusions of relevance to the world of today.





It is easy to forget that a very substantial role of the state in our society and economy is a very recent historic phenomenon.  A century ago, total government expenditure was less than 10 per cent of GDP in OECD countries.  The first big jump in the share of government occurred in addressing the heavy toll on economic and social systems caused by the Great Depression.  Then postwar confidence in government encouraged demands for it to do more.  Thus, OECD countries expanded the welfare state such that by the mid-1990 total government expenditure had grown to close to half of GDP – most OECD governments spend more time moving money around the economy in the form of transfers and subsidies than they spend providing traditional public goods.  And much of the developing world embarked on state-dominated development strategies and so government expenditure now amounts to more than one-quarter of GDP on average in these countries.


What is the balance sheet of this experience?  Governments have done many good things in delivering education and health services, and in reducing social inequality.  But not all governmental actions have been beneficial for development.  Some governments embarked on fanciful schemes which discouraged private investors.  Powerful rulers sometimes acted arbitrarily.  In many cases corruption became endemic, and development faltered and poverty endured.


Even for those successful cases, government is now faced with new challenges in the globalizing world economy.  Globalization and democracy have narrowed the scope for arbitrary and capricious behaviour.  Taxes, investment rules and economic policies must be ever more responsive to the parameters of the globalized world economy.  Markets and citizens vexed by state weaknesses have come to insist, often through grassroots and other NGOs, on transparency in the conduct of government.  The clamor for greater government effectiveness has reached crisis proportions in many developing countries where the state has failed to deliver even such fundamental public goods as property rights, roads, and basic health and education.  It was the state’s long-term failure to deliver on its promise that led finally to the overthrow of communism.  Overall, while the state is central to economic and social development, it is not as a direct provider of growth, but rather as a partner, catalyst and facilitator.


The World Bank’s overall conclusion is twofold.  First, it is important to match the state’s role to its capability.  Where the state is weak, government intervention should be carefully assessed.  These states should stick to the basics.  Many states bite off more than they can chew.  The second leg is improving state capacity by reinvigorating public institutions.  This means designing effective rules and restraints, to check arbitrary state actions and combat entrenched corruption.  It means subjecting state institutions to greater competition, to increase their efficiency.  It means increasing the performance of state institutions, improving pay and incentives.  And it means making the state more responsive to people’s needs, bringing government closer to the people through broader participation and decentralization.


What are the basics, according to the World Bank?  They are things like establishing a foundation of law, maintaining a non-distortionary environment, investing in basic social services and infrastructure, protecting the vulnerable and protecting the environment.  Markets and government are complementary.  The state is essential for putting in place the appropriate  institutional foundations for markets.  Where governments are failing to ensure law and order, and protect private property, private investors will be discouraged.    And government’s credibility – the predictability of its rules and policies and the consistency with which they are applied – can be as important for attracting private investment as the content of those rules and policies.


What should the state do if it is capable of going beyond the basics?  The state can help households cope with certain risks to their insecurity by insuring against destitution in old age through pensions, against devastating illness through health insurance, and against job loss through unemployment insurance.  Well-designed regulatory systems can help societies influence market outcomes for public ends.  Regulation can help protect consumers, workers and the environment.  It can foster competition and innovation while constraining the abuse of monopoly power.  Making the best use of the new options emerging for private provision of infrastructure and social services will also rely, often, on a good regulatory framework.


Industrial policy can play a role when markets are underdeveloped, as the state can sometimes reduce coordination problems and gaps in information and encourage market development.  Many of today’s oldest industrial economies used various mechanisms to spur the growth of markets in their early stages of development.  The US government was instrumental in constructing the first telegraph line and in agricultural research.  And the Internet is only the latest in a long line of remarkable scientific and technical advances made possible by early and significant government support.  Japan, Korea and other countries in East Asia used a variety of mechanisms for market enhancement, in addition to securing the economic, social and institutional fundamentals.  But the ability to choose wisely among these interventions and use them effectively is critical.  Ill-considered trade, credit and industrial policies can and have cost countries dearly.


Countries that have pursued an activist industrial policy successfully could not have done so without strong institutional capability.  The key is to have a good fit between the state’s institutional capabilities and its actions.  Three basic incentive mechanisms can be used to improve capability: effective rules and restraints; greater competitive pressure; and increased citizen voice and partnership.  A major thrust of any effective strategy to reinvigorate the public sector will be to reduce the opportunities for corruption by cutting back on discretionary authority.  Civil servants can be motivated to perform effectively through mechanisms like merit-based recruitment and promotion, and adequate compensation.  But countries struggle to build the institutions for an effective public sector.  One reason the task is so difficult is political.  Strong interests may work to maintain the status quo, whereas those who lose out from this arrangement may be unable to exert effective pressure for change.


Globalization can be a threat to weak or capriciously government states.  But it also opens the way for effective, disciplined states to foster development and economic well-being, and it sharpens the need for effective international cooperation in pursuit of global collective action.  The state still defines the policies and rules for those within its jurisdiction, but global events and international agreements are increasingly affecting its choices.  People are now more mobile, more educated, and better informed about conditions elsewhere.  And involvement in the global economy tightens constraints on arbitrary state action, reduces the state’s ability to tax capital, and brings much closer financial market scrutiny of monetary and fiscal policies.


Globalization gives rise to demands for states to participate in global collective action.  Economic, cultural and other differences between countries can make such cooperation difficult.  But stronger cooperation is clearly need for at least five major concerns that transcend national borders: (i) managing regional crises which often involve refugee relief and rehabilitation; (ii) promoting global economic stability in light of especially volatile capital flows; (iii) protecting the environment and adapting to the effects of climate change; (iv) fostering basic research and the production of knowledge which can often be beneficial for tackling tropical diseases and helping developing country agriculture; and (v) making international development assistance more effective.


The World Bank’s basic premise is that state capacity is much greater in the wealthy OECD countries.  It also argues that governments are more effective when they listen to businesses and citizens and work in partnership with them in deciding and implementing policy.  In this regard, the developed countries sometimes have as many challenges as the poorer countries, even if the nature of those challenges is somewhat different.


.  Governance in the US is now more driven by vested interests more than the common good.  Wall Street lobbyists managed to secure substantial liberalization of the financial sector which contributed to the current global financial crisis, and they are now very actively lobbying to try to prevent a tightening of financial regulation.  In addition, most shamefully, almost half of the US population does not have health care insurance, and once again the insurance and other industry lobbyists are making it difficult and perhaps preventing President Obama’s efforts to reform the US health care system.

.  Japan’s developmental state has literally covered the country in useless infrastructure, like roads that go nowhere and unnecessary dams, as a way of currying favour with construction companies and creating jobs with the ultimate objective of indirectly buying votes.  This has resulted in Japan’s public debt rising to the level of 200 per cent of GDP!  With the recent election which threw out the Liberal Democratic Party and replaced it with the Democratic Party of Japan, we can only hope that this wasteful vote-buying machine will now be a thing of the past.

.  Most of Europe’s economies are riddled with regulations that protect certain groups, and make the collective interest suffer.  The consequence is that ten years after the introduction of the euro, GDP per capita in euroland is still 30 per cent lower than in the US, unemployment is much higher, and innovation sluggish.


So while government is back, government performance is not always very effective in most of the world’s countries.



The State in a Changing World, World Development Report 1997.  Published for the World Bank by Oxford University Press.


Dogs and Demons: The Fall of Modern Japan (2002), by Alex Kerr





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