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Advice on strategic issues for governments

The corporate state

David Skilling
3 February 2012

There has been much discussion on whether free market capitalism is being dominated by more authoritarian versions – The Economist led recently with an article on ‘the rise of state capitalism’ and it was a key topic of conversation at Davos. I don’t think state capitalism is a credible option for governments in the developed world. But many advanced economies are clearly struggling with slow growth and widening income distributions, and this has stimulated debates about the role of the state. So this week’s Observer offers some thoughts on how advanced economy governments should think about their role in the economy.

Responding to global realities
The process of globalisation over the past 20 years has created pressure for a change in the role of government. In particular, these global dynamics mean that an increasingly important role of government is positioning their economies to compete. There are two related aspects to this. First, countries are competing to provide an attractive environment for internationally mobile factors of production. To an increasing extent, people, capital, and companies can move across borders and are looking for the locations with the best returns and opportunities. This international factor mobility, combined with a realisation that the world is not flat – and that smaller or peripheral countries need to work hard to attract and retain resources, as well as the increasing size of the internationally exposed parts of economies, make competing a much more important priority for growth. The second element is acting to develop a competitive domestic environment that supports locally-based firms to succeed in global markets. Firms are the engines of growth, but the quality of the environment is a key success factor for them – and influences their performance in generating income and creating jobs.

Although this model of competition is private sector led, it suggests a deliberate role for governments in positioning their countries to compete in a complex global environment. Countries need to be distinctive in some way to compete successfully for mobile factors against other locations, and to provide an environment that enables firms to compete successfully. So in addition to the broad-based policies to lift productivity across the economy, for many advanced economies the important priority in delivering material improvements in economic performance is achieving competitive strength in key parts of the economy.

How countries compete
Countries can choose to compete in different ways. Some develop competitive strength around sector ‘verticals’, such as the life sciences or financial services, while others focus on ‘horizontal’ capacities such as tax rates, infrastructure quality, or the nature of the innovation eco-system. There is no single policy template for success – Singapore and Denmark, for example, operate very different models. There are successful countries that have high and low tax rates, high and low levels of R&D spending, heavy and light labour market regulation, and so on. But the policy settings do need to be coherent and to respond to global realities; if countries are going to maintain high levels of government spending, for example, the economy needs to be sufficiently productive to support it. And these choices will change through time; the countries that succeed are those that adapt when the competitive landscape or their domestic situation changes.

A key aim here is to create an environment in which private firms can prosper. But the strategy needs to go beyond GDP maximisation, and will also be shaped by other objectives. For example, many countries are looking to compete in ways that generate inclusive growth and that take account of the implications for employment and the income distribution. These considerations may influence choices about which sectors or capacities to invest behind (e.g. those with particular employment or wage profiles) or the design of tax and transfer policy. Countries do have choices about where to position themselves to deliver against multiple objectives, and governments need to have a considered view on this. There are constraints of course, but it is not a race to the bottom.

The corporate state

The economic importance of a deliberate competitive strategy is increasing as countries face a global context that is more intensely competitive, more volatile, and with more moving parts. Advanced economies will need to determine the basis on which they want to compete to position themselves in the global economy to generate the outcomes they want, given the options that they have available. In this model, governments assume a more deliberate role – but one which is focused on shaping the environment for private companies to compete successfully. Although some advanced economy governments have significant portfolios of financial and commercial assets (such as Norway and Singapore), this is clearly not a model of state capitalism in which governments rely on the direct control of companies to pursue their national interests. State capitalism is a model that has worked well for some countries when they are developing rapidly, but is unlikely to be helpful for advanced economies.

For advanced economies, the choice is not between state capitalism and a hands-off free market version of capitalism. Rather, governments will be seeking ways to engage deliberately with the dynamics of globalisation so as to position their countries to compete in the global economy. To do this, governments need a coherent economic strategy, to manage risks and build resilience, to construct a portfolio of external relationships, and so on. It was common a decade ago to talk of the ‘market state’, in which countries had to compete in open, globalised markets using a slimmed-down role reminiscent of Tom Friedman’s ‘golden straitjacket’. But perhaps the better way of thinking about the role of government now is the ‘corporate state’; a more vertically integrated approach in which governments deliberately shape the competitive profile of the economy to respond to the emerging global environment (much as a corporate would do). Meaningful changes are required to the models employed in many advanced economies given the economic and social outcomes being generated, but this involves an adaptation of market-based capitalism to respond to the current process of globalisation rather than a shift to a fundamentally different model like state capitalism.