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Global macro & geopolitics from a small economy perspective

Strategy needed, not policy fatalism

David Skilling
20 January 2012

Across the developed world, governments are facing a series of structural challenges associated with a changing global environment. Some of these were discussed in my last note, which offered some perspectives on the big themes that will dominate the agendas of governments in 2012. One increasingly common response to this is policy fatalism, a sense that there is not much that governments can do. This week’s Observer argues that fatalism is unnecessary by pointing to a group of countries that are deliberately – and successfully – engaging with the global economy, and suggests that governments invest in building strategic capacity to enable them to respond.

Old ideas for a new normal
At the core of many of the issues facing advanced economies is that they have not yet adequately responded to the structural changes to the global economy that have occurred over the past 20 years. My reading of economic history is that countries that do well on a sustained basis have an ability to adapt to changes in the external environment, and that countries that do not adapt do rather less well. This is particularly so for small countries, but increasingly so for large countries as well given the nature of globalisation. So the important question to debate is how countries adapt themselves to a new global environment.

And yet despite the increased noise on issues like jobs and inequality, the policy debate in the new normal seems remarkably similar to that in the old normal. As one example, Larry Summers wrote in the Financial Times a fortnight ago that there was no need for structural reform, just “proper fiscal and monetary policies”. This perhaps reflects a sense that there is nothing that can be done in response to structural forces such as intense globalisation, and that advanced economies lack policy instruments to deal adequately with issues like growth and inequality. Coupled with a lack of public trust in many governments, a sense of policy fatalism appears to be growing across advanced economies. This is both dangerous and unnecessary; although the global environment is challenging, countries do have meaningful choices to make to respond (as I have argued previously). To make this more concrete, consider a group of advanced economies who are deliberately engaging with these global forces.

The future is already here, it’s just unevenly distributed
Although attention tends to focus on large countries or the G20, it is the small advanced economies (with populations of less than 20 million) who have real insight to offer in this regard. Small economies are deeply exposed to the emerging global economy, and have had to learn to respond. Not all small countries have done well, but many – from Europe to Asia – have out-performed. As a group, they have held their share of global GDP constant over the past 20 years (while the large advanced economies have lost share), have grown their exports and foreign investment strongly, are ranked as among the most competitive economies in the world, and perform well on social measures like income inequality. Although there are differences in scale, this small country experience shows that advanced economies can successfully adapt to a changing global environment – and that fatalism is not the right response.

There are several important characteristics that I think are relevant to explaining this performance (which I’ll describe in a full-length discussion paper on small countries to be released in a few weeks). But one important characteristic is that small countries have a more deliberate focus to policy, which is focused on positioning the economy for competitive advantage in the global economy. The standard macro and micro policy fundamentals are important, but layered on top of that is deliberate competitive strategy in which policies are designed to ensure that the national economy is positioned distinctively in some way. Interestingly, there is no single policy agenda; although an emphasis on R&D spending, fiscal balance, and social insurance are common features, small countries choose to compete in a variety of ways depending on their circumstances (Denmark, Singapore, Hong Kong, and Switzerland have quite distinct approaches). Small country policy debates tend to be informed by a need to respond creatively to the challenges and opportunities they face. But not fatalism.

The business of government is strategy
To engage in this way will require governments to invest in capacity to more deeply understand their place in a changing world, and to develop a policy agenda that responds deliberately to domestic and global realities. In other words, to perform in a disruptively changing world, governments need to do strategy. However, my observation is that strategy is done very patchily across advanced economy governments. This is partly because many advanced economy governments have under-invested in strategy over the past few decades. Sometimes this was because there was no perceived need due to the strong economic and social outcomes being generated. Sometimes there was a view that governments should not invest in strategy because the role of the government was simply to set the ground rules and then to get out of the way. And governments often treat strategy with some scepticism, wanting to get stuff done today.

But strategy is the core business of government. Yes, the efficient delivery of public goods and services is important. But where governments add substantial value is in getting the key strategic choices right; having a clear view on medium-term direction and on policy priorities, knowing when a change in direction or emphasis is required, and so on. In the current climate of change, this matters more than ever. To enable governments to sensibly determine how to engage with the global economy, the strategic policy-making machinery needs to be strengthened. Otherwise, fatalism is likely to become increasingly common.