February 15, 2002

The Partnership Dance Between Government and Business

For at least two centuries, if not longer, it has been clear that modern economies can be successful only if they are mixed economies. For at least two centuries businesses and governments have performed a complicated partnership dance, at times switching parts of their roles, watching each others' spheres of influence expand and contract. Now we are about to enter another measure of this partnership dance. One thing, however, remains clear: it is a partnership, for neither business nor government can flourish without the other. In the absence of private business government cannot fulfill its promise to citizens to create and guard prosperity. In the absence of government, and its regulatory and supervisory role, business simply cannot function.

We today know that modern industrial economies can be successful only if they are mixed economies because of the history we have lived, a history in which the extremes have proven so unpleasant. Socialism-as-we-knew-it produced either too many meetings or too little freedom. Over time it led to extraordinary low levels of efficiency as the absence of hard budget constraints for organizations meant that there were no effective counterpressures to bureaucratic stagnation. On the other side, attempts to diminish the role of government and have a "market only" society proved to be pure fantasy. Too much of what is needed for a modern economy to run are "public" goods that an unfettered government-free market simply will not provide. Too many disputes over who owns what and what exactly are contractual obligations must be refereed by someone--and that someone is the government. Too many times people have seen high unemployment produced by macroeconomic upset uncountered by the government. Moreover, there is no guarantee that the market will produce a politically-acceptable distribution of income unless the government puts its rather large thumb on one side of the scale. To try to run a market economy without a large government role inevitably leads to the reemergence of some entity--often brutal, inefficient, and corrupt--that performs the necessary governmental functions.

Even the mid-eighteenth century French economists who coined the phrase "laissez faire, laissez passer" when asked what government economic policy should be did not really mean it. They were reacting against more than a hundred years of ever-tighter mercantilist restrictions when they asked for merchants and producers to be let alone. But they were not really asking for the government to withdraw from commerce and industry. The "night watchman" state that they thought necessary and optimal was in reality a very powerful and activist state. It secured property from theft and violence. It enforced contracts. It controlled regional notables who would otherwise use their standing and their resources to extort wealth. Most important, perhaps, it controlled its own functionaries so that judgments were given and rights enforced according to the law rather than according to who had offered the largest and most recent bribe. Most states throughout history--many states today--are not powerful enough to carry out the taks of the night watchman "minimal" state, and commerce and industry suffer mightily as a result.

By the end of the nineteenth century's industrial revolution there had arisen strong demands for more modes of government action. British investors in America's trans-continental Central Pacific railroad found that the principal managers of the Central Pacific--Colis Huntington, Chester Crocker, Mark Hopkins, and Leland Stanford--had dealt with their own privately-owned construction firm to pump tens of millions of nineteenth-century dollars out of the railroad and into their own pockets. The response to these and other large-scale investment scandals was a demand from the wealthy that the government--in the form today of the Securities and Exchange Commission and the Delaware Chancery--enforce the doctrine that corporate managers, directors, auditors and others were trustees and stood in a fiduciary relationship to the corporation's shareholders. Other demands came from other quarters: workers demanded wage and hour regulation and support for collective bargaining; consumers demanded that the government monitor and assure quality; large-scale producers like the Swift meatpacking company demanded that whatever health and safety regulations were set be set in a uniform manner across their entire span of operations, for large-scale enterprise would be impossible if each small local jurisdiction could set and enforce its own idiosyncratic quality, health, and safety standards.

The first two-thirds of the twentieth century saw people and interests put further demands on how closely the government needed to regulate and work with businesses. There were demands for the government to stabilize prices. There were demands for corporations to serve as arms of the social insurance state, providing benefits to workers and their families. There were demands for governments to run and own the "commanding heights" of the economy--the large-scale potential monopolies on which other businesses depended so much. There were demands for the government to lead in economic development through indicative plans and industrial regulation--demands for a "developmental state."

The past two decades have seen the pendulum swing back. Consensus opinion on the proper balance point in the mixed economy has swung from "social democracy" to "neoliberalism." The belief grew that in the industrial core regulation had too-often led to the capture of regulatory agencies by would-be monopolists, and that public ownership had sacrificed economic efficiency and consumer welfare in order to provide cushy jobs for politically well-connected boys. The belief grew that in the developing periphery attempts by the government to guide industrial and economic development had been un- or counter-productive, leading in most cases to massive corruption and slow growth. There are, as World Bank economist Lant Pritchett put it, "few things worse than state-led development led by an anti-developmental state." Hence the the past two decades have seen enthusiasm for lowering corruption-enabling trade barriers, reducing the size of government, and giving freer rein to "unfettered" market forces--the neoliberal trio of deregulation, privatization, liberalization.

But we have come to the end of this last two-decade swing. The Asian financial crisis, the effective bankruptcy of Long Term Capital Management, and the collapse of Enron have made everyone aware that financial markets simply do not work well if the government withdraws from or is unable to perform its proper regulatory functions. It is more clear today than before that an undirected market cannot be expected to provide what Joseph Stiglitz calls "global public goods"--global environmental control, global macroeconomic stability, improvements in the world distribution of income, research into important but underfunded health issues like tropical diseases, and others that can only be provided not just by governments but by large coalitions of governments. It is more apparent now than it was twenty years ago that the mere adding-up of private demands does not produce a total balance of supply and demand that is in the public interest. Is there any reason for AIDS drugs to be so expensive in Africa? Why is there so little pharmaceutical research and development on tropical diseases, and so much on hiding the signs of aging?

During the past twenty years, as the pendulum has swung to the "market" side, the principal task of those standing athwart the tide of history yelling "Stop!" has been to try to preserve the most valuable parts of social democracy and social insurance against the general pruning of the role of government. During the next twenty years, as the pendulum will swing back to the "government" side, the principal task will be different. It will be to keep the expanding sizes and roles of government from creating too much red tape or causing too much bureaucratic inertia. It will be to retain the insights of the benefits of competition, and the value of entrepreneurship. It will be to devise new forms of government that will avoid either the large-scale corruption found in so many of the trade regulations of the past, or the large-scale capture of regulatory agencies in the interest of providing oligopolists with a quiet and profitable life found in so many of the regulatory commissions of the past.

Posted by DeLong at February 15, 2002 10:12 AM | TrackBack


Personally, I am amazed at how badly the markets
are failing to deal with the accounting scandal.

Arthur Anderson is dead, and dodgy bookeeping has
been forgotten.

When was the last time anyone saw a follow-up
article in a Time, a Business Week or something

I mean, it's just so 2002.

And dont get me started on the games companies are
playing with pension funds ...

Ian Whitchurch

Posted by: Ian Whitchurch on February 20, 2003 06:48 AM
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