Ajay Chibber argues that the state is still an important player in economy. Its role, however, in the developed and developing countries will differ. He cautions that markets are wary of rising government debt in the developed countries that have launched massive fiscal stimulus to save the economy from going down the drain.
So what is the appropriate role of the state after the financial crisis? In the developed world, a permanent expansion is impossible, especially as ageing populations put further pressure on public finances. With almost half of GDP in state hands, it is not surprising that large stimulus packages helped stop the markets going over the edge. But with public debt in the developed world exceeding GDP, there is less scope for fiscal activism. If economies sink back into recession, further fiscal expansion could unnerve markets. In the long run, debt sustainability may require a fundamental review of the welfare state.
It is too early to predict the demise of the nation state. The state remains the ultimate protector of people’s interests as markets overreach, on both the upswings and the downswings of capitalism. Self-regulation – à la 16th-century Scottish bankers – or a light-touch regulatory system cannot be the solution for the modern financial world. A co-ordinated, activist and sceptical regulatory system is needed. The Group of 20 and more broadly the UN can play a bigger role.
Asian-style state-led capitalism has performed well during the crisis. With low public debt at around 40 per cent of GDP, Asia has shown the world that future capitalist development depends on an activist state, but not necessarily a large one. Unburdened by expensive welfare provision, developing countries in Asia and elsewhere must now build social protection systems but with “workfare” rather than European-style “welfare”.
With global warming – the mother of all market failures – looming, the role of the state becomes more critical. Investment in green technologies and public infrastructure must be the priority.
In terms of size, the state has reached its limits in the developed world. But there is a case for increasing its role in sectors such as banking and finance, as well as in addressing climate change. In the developing world, government needs to play a bigger role in social protection, basic services and rural infrastructure. Addressing corruption and ensuring delivery will be key to its legitimacy.
What will matter is what the state does, not how big it is. A smarter, more active state is the way forward.