By Mauro F. Guillen
and Emilio Ontiveros
Dealing with the present economic and financial crisis requires not only appropriate policies but also accurate and sustained policy implementation. Most of the debate about the best way to address the challenges confronting Europe and the United States has focused on policy design as opposed to implementation. As governments ponder new policies to cope with the evolving nature of the crisis, it is becoming increasingly urgent to examine the extent to which they are in a position to actually implement them.
The capacity of governments to act and to implement policy has deteriorated massively since the 1990s. The diseases of “eurosclerosis” in Europe and “gridlock” in the United States have spread perilously across most branches of government and state agencies. Governments are now more crippled than ever because of funding cuts and a heavy debt burden, which imposes further constraints on its ability to act.
Most importantly, governments and the state bureaucracy have lost legitimacy in the eyes of key stakeholders including business and the public. Public opinion polls show that faith in the ability of governments and state officials to make decisions to tackle economic and social problems has collapsed on both sides of the Atlantic. Politicians are at an all-time low in terms of public approval. Business is no less skeptical about the ability of governments to address its concerns, and has mostly concluded that the less the government interferes, the better. Many people have come to equate small government with good government.
Our view is that the size of government itself should be debated and designed separately from its effectiveness. Determining the right size of the state with a view to promoting sustainable economic growth over the long run is a different issue altogether from ensuring that whatever state apparatus is left after adjusting its size has the capacity to address problems, especially during times of crisis.
Let us offer two examples of why the size of the state should not be driving the debate as to the institutional mechanisms required to prevent, manage, and overcome economic and financial crises such as the one besetting Europe and the U.S. at the present time. First, consider the case of the need for a financial institution to absorb “bad” assets. Many policy experts have concluded that it makes sense for countries to set up a state-owned bank that would be very small during normal times, but could grow in order to unload bad assets from the banking sector during a financial crisis. This type of solution was implemented in Sweden during the 1990s, leading to a swift and relatively painless resolution of its banking crisis. By contrast, for years Japanese banks continued to be burdened by bad loans after the bubble burst, which led to a severe banking crisis after 1997 which cost the government the equivalent of 24 percent of GDP compared to less than 4 percent in Sweden.
A second example has to do with the actions by the Federal Reserve, the Bank of England, and the European Central Bank during the current crisis to support government bonds through the so-called “quantitative easing.” If it weren’t for the actions of the central banks, the global economy would now be in a much worse shape. Fortunately, during the last twenty years many governments around the world granter their central banks a statute of independence from political influence. The banks developed their skills at monetary policy by hiring expert policymakers and economists. Although the European Central Bank’s relatively shy purchases of sovereign debt when compared to the Fed and the Bank of England have been severely criticized in recent weeks, it represents the only European policy mechanism in place at the present time that can act promptly to prevent the crisis from getting worse.
The present crisis represents a stark reminder that we can’t do without a state apparatus that works, especially when economic and financial events demand massive action. We must strengthen the effectiveness of the state to formulate and implement sound policies without necessarily making it bigger.
Mauro F. Guillen is Director of the Lauder Institute at the Wharton School. Emilio Ontiveros is President of AFI and a Professor at Universidad Autonoma de Madrid.