Redefining balance between state and free enterprise

February 2, 2009

ashrafghani31Ashraf Ghani is Chairman of the Institute for State Effectiveness and co-author with Clare Lockhart of “Fixing Failed States: a Framework for Rebuilding a Fractured World“. His opinions are his own. –

The current financial crisis has called into question our trust in globalization as a spontaneously generated order. Such orders, while of human making, are not of human design. The market can be seen as a force capable of generating solutions to the most difficult of economic problems.

We should not forget, however, that the visible hand of the state is necessary to set the appropriate regulatory mechanisms that keep the market functioning according to a set of rules, and to put in place the risk management systems to deal with market failures. The return of the state to the center stage of economic management in the current global economy highlights the shift in values that will guide economic policy for the next decade, or possibly even the rest of the century. All business models operate with assumptions regarding the enabling regulatory environment. With the return of the state to active management of the financial sector in the short-term, and the emerging consensus on a more assertive role by the state in the regulation of the market over the longer-term, business models now require major revisions.

The crisis is global in nature, yet the response mechanisms have been predominantly national in character. The resumption of prosperity is going to require concerted global action, and the most powerful nations will have to agree to give up some of their powers in the national arena in return for collaborative powers within a more predictable global arena. Agreeing on such rules requires a shift in values to highlight the need for cooperative solutions and rule based behavior, rather than unilateral actions based on individual interests. While the state is “back in”, the market that it needs to regulate is fundamentally different from the national markets after World War II.

The market operates with speed, while bureaucracies are bound by rules and procedures. We must now arrive at regulatory instruments that can satisfy public demand for accountability while having the speed to keep up with the market. Failure to establish alignment between the pace of the market and government will be extremely dangerous.

Since the time of U.S. President Ronald Reagan and British Prime Minister Margaret Thatcher in the 1980s, the market has been seen to provide both the instruments for assessing risks and the instruments of risk management. Trust in market ratings systems led to underestimation of the risks to which the banking sector was exposed and the massive failure of the market has now made the state, and thereby the public, assume management of risks.

The challenge both to the state and business is going to be in the determination of the balance of risks to be assumed between a revitalized market and an interventionist state. Decisions regarding these options will have immense consequences for they way business models are to be built, operated and endure. Assumption of a more assertive role by the state requires a massive shift in the values of public service as well as the skills, mental models and mechanisms of interaction between the government and the market.

In the short term, there is the challenge as to where the people necessary to perform the regulatory function by the state will come from- will they be drawn from very financial industry that was responsible for the crisis, or are there capabilities outside the system that can be harnessed for this task? In the West, several generations have been steeped in the assumption of a minimalist state, and a transition of this sort will not be easy.

We must also consider the issue of accountabilities both for legislatures and for the public. Historically, the power of the purse has been seen as mechanism to check the power of the executive branches of government and make them justify the claim to resources on the basis short-term allocations. Swift executive action is going to require agreement on mechanisms for flexible decision-making, while also satisfying this demand for accountability.

It is unclear as yet how legislatures and publics are to be convinced that the government and the market are going to use vast amounts of public resources through agreement on values frameworks that do not yet exist.

Business models are going to require entirely new ways of thinking, acting, collaborating and competing. Leadership that can both satisfy the shareholder in terms of the rate of return, and the public in terms of accountability, will have to be inherent parts of business models in an era when public money is essential to survival and revitalization of the market. Business leaders must now answer to two masters simultaneously- the public, whose massive resources are being used to rescue them- and shareholders- whose trust they must regain to ensure sustainability in the future.

 The public, both as shareholders and stakeholders, will play a vital role in the legitimacy and sustainability of business going forward. Designing a new framework for the governance of economic globalization is going to require new thinking if we are to harness the market to restore world prosperity and stability.

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