Laissez-faire still rocks but tighter regulation is needed

The current global financial crisis urged governments in several developed, emerging and developing countries to adopt policies and measures that allowed them to own partially or wholly private financial institutions. The emerging involvement of governments in the financial system and in the real economy has raised eyebrows and the question: What is an appropriate role for the state in the economy?

In the relevant literature, the role of the state in the economy changed during the 20th century from regulatory to developmental and from there to adjustment. However, the role of the state since the advent of the third millennium has been a mix of regulatory and adjustment.

In the market economy, private enterprises are assumed to produce goods and services that satisfy demand at the least costs, otherwise they will not be able to compete and stay in the market.

Little impact

In this environment of the market economy, the role of the state was regulatory, issuing laws, legislation and keeping regulations and security. The role of the state remained relatively limited until the thirties of the 20th century. Thus, the state had little impact on the economy during its regulatory role. In 1929, the share of the US government expenditures in the gross domestic product was approximately 10 per cent, and by 1985 increased to 35 per cent. The beginning of the period relates the Great Depression. The expanded role of the state in the economy occurred after the Second World War and was based and encouraged to a great extent by the theoretical underpinnings of the renowned English economist, John Maynard Keynes, who called for state intervention in the critical times to increase aggregate demand by increasing public expenditures when the private sector does not spend enough so as to keep the engines of production running and workers in their jobs.

During this developmental stage, from the 1940s to the 1980s of the 20th century, the state shouldered extensive economic and social activities and adopted basic responsibilities of keeping economic growth, price stability and full employment. Thus, the state intervention in the economy became a given axiom and planning became a tool to achieve economic and social development. In spite of the important achievements in the development sphere in health, education, infrastructure and employment by the state, those achievements were below the targeted objectives as evidenced by weak conditions of the 1980s which promoted a review of the role of the state in the economy and paved the way for the shift to the adjustment role which was based on three pillars, namely:

--Economic liberalisation: elimination of restrictions and barriers on foreign trade, promoting competition and supporting the private sector;

- Public sector reform: improving the management of public expenditures, reforming civil service and improving performance of public enterprises either by privatisation or by restructuring;

- Macro economic policies to achieve stability of the economy.

In many countries, including Arab countries, governments adopted the adjustment role and liberalised their economies and reformed their public sector by selling many enterprises to the national and foreign private sectors and paved the way for a special and distinguished role for the private sector under the umbrella of market economy and globalisation, characterised by large flows of trade, capital and information.

The current global financial crisis has ignited the debate as to the appropriate role of the state in energising the economy through expansionary fiscal and monetary policies and other measures, even nationalisation if that could prevent the economy from sliding to economic depression, which would cost any country great economic and social hardships.

Regulation versus intervention

The current global crisis started in the financial system in the United States and its sub prime mortgage market in particular, and spread from there to financial markets of many countries.

The turmoil in financial markets impacted negatively the global economic activities and thus lowering expected growth rates in 2008 and 2009. The state should have a strong and effective role in protecting the financial system by regulation and supervision.

Observations in different regions and countries show that unless the financial system is well regulated and supervised and reviewed on a regular basis, the concerned country will face the risk of financial and economic crises. If this is the case, then the state should establish an effective system for supervising banks, other financial institutions including financial markets, with the objectives of stability of the financial system and its smooth operations. The state should also ensure accurate and timely information, data and transparency in transactions. The state should make sure that well informed and trained supervisors are available. Above all, the government should be well regulated, informed and non-corrupt. Such a government requires a transparent regulatory framework, well trained and paid civil servants, and strict commitment to good governance.

The writer is an economic consultant based in Dubai