Custom Class: header-inner

Custom Class: hero-banner-wrapper

Is a strong state a prerequisite or an obstacle to economic growth?

Harry Young (Lower Sixth)

The role of a central governmental power in the economy has long been a source of contention between economists who disagree over the extent of government intervention needed to reach efficiency and sustained economic growth. With the emergence of Keynesian policies during the Great Depression, that seemingly contradicted the views of Classical economists, and subsequently the debate following the 2008 financial crisis, it is important to not only focus on the normative ideas of whether a state should interfere in the economy but their capacity to interfere and what impact this has. In this essay, I will start by defining a strong state, laying the foundations to analyse how the state has impacted economic growth globally. Developing economic ideas often involves the interplay of theory and observation, with scarce room to conduct scientific experiments, which is why I will be turning to the recent history of global economic development and a series of examples to show that a strong state is indeed necessary to foster economic growth. The role of the state will be analysed in the context of these case studies and combined with a range of prevailing economic theories from the past to determine how the strength of each country has influenced economic growth. In this essay economic growth will be defined as the long-term expansion of the production possibilities frontier which has accommodated a rise in Gross Domestic Product.[1]

 

It is important to first consider how one defines a 'strong state.' Traditional concepts of a strong state may be that of a country that possesses a strong military, an advanced economy, and a certain level of geopolitical influence. In The Origins of Political Order, political economist Francis Fukayama argues that a stable country must consist of three characteristics: a strong and modern state, accountability, and the rule of law.[2] While these are valid theories, a general consensus of a strong state is that it is a country capable of effectively carrying out legitimate policies without easily bowing to pressure from domestic and foreign stakeholders or succumbing to invasion, revolt, or a lapse into esoteric policies.

 

As suggested by many Classical economists, the function of the government, at its very minimum, is to ensure that Adam Smith's ‘invisible hand’ can work freely allowing the price mechanism to efficiently allocate scarce resources throughout society. In 1962, Austrian-school economist Friedrich Hayek published The Constitution of Liberty in which he argued that the government should act only to preserve spontaneous order, through protecting private property rights, enforcing contracts, and acting against the forces threatening to undermine the rule of law.[3] In the 1770s, for example, patent agents began to emerge in Britain, resulting in protection of intellectual property becoming more obtainable to entrepreneurs. This incentivised innovation that contributed massively to the Industrial Revolution; innovation is at the heart of Schumpeterian growth and creative destruction, as described by Joseph Schumpeter, which drives economic development. Contrasting to this, the devastating impact of a lack of extractive capacity and state "monopoly of the legitimate use of violence" can be observed today.[4] An unstable environment, resulting from a weak government can harm the economy through the destruction of infrastructure, a reduction in the labour force, the opportunity cost of funding armed conflict and rampant inflation that often follows. To illustrate, in a 2007 report titled ‘Africa's missing billions,’ Oxfam estimated the cost of warfare in Africa to be equal to the entire amount of international aid that the continent receives.[5] Furthermore, data from the International Monetary Fund shows a clear decrease in economic growth as conflict intensity levels increase. In the long term without such basic functions for the workings of the economy, it is clear that economic growth will almost certainly lag behind.[6]

 

Sub Saharan Africa Graph

 

It is also true that many strong nations could find themselves in the precarious situation where government policy can be hijacked by a kleptocratic elite or, more likely, strong government intervention can create perverse incentives. Too much strength that translates into excessive intervention in the economy through taxation, subsidisation and price controls can distort the markets causing government failure, but the state can act at its own will if it is strong enough to suppress opposition out of a misguided sense of doing what is “right.” Naturally, this has led us onto the debate over to what extent the government should intervene in the economy; it is an important issue which cannot be ignored. Taxes, for example, can artificially distort how markets work to allocate scarce resources often with the purpose of raising government revenue, reducing inequality, or reducing the purchase of certain goods. Direct taxes on demerit goods should disincentivise the purchase of them (shifting the supply curve to the left) but demand for such goods is often inelastic, resulting in more disposable income being spent on harmful goods rather than useful goods. Other policies to combat demerit goods, such as the alcohol prohibition enacted in Saudi Arabia in 1951, often lead to underground economies that incentivise criminal activity and violence. Often ‘the market,’ left alone, handles situations more effectively than the government.

 

A stronger expression of this government intervention was seen in the planned economy of the USSR, until its collapse in 1991. Poor economic performance, relative to its global competition, due to the inherent inefficiencies of a state-controlled economy ultimately led to the Perestroika reforms, which began to decentralise economic activity, marking the apparent failure of the command economy. In an article called 'Economic Calculations in the Socialist Commonwealth,' Ludwig von Mises pointed out these inefficiencies, primarily that the economy was too complex for central planners to determine prices and that prices can only be provided by the market, which takes all factors into account.[7] Furthermore, the form of market socialism operated in the Soviet Union often led to targets being met through shortcuts, resources being hidden from central planners, and considerable waste. Low levels of productivity, created by the extreme levels of government intervention that were permitted by the strong state, naturally lead to low levels of economic growth. As well as this, excessive state control can dictate where the factors of production are allocated which will not always match up with where aggregate demand is concentrated. Estimates as to how much the USSR actually spent on their military vary but one such estimate is around 20% of Soviet GDP. This spending, for example, carried an immense opportunity cost in the production of producer and consumer goods that were forgone to fund national defence.[8]

 

Despite this, beyond the provision of basic security and law, there are areas (that are not at the extreme end of the spectrum) in which mainstream economists agree that the government should have an active role in, primarily the correction of market failures caused by externalities (such as pollution) and the concentration of market power (through monopolies and cartels). This approach echoes the policy of ordoliberalism adopted by the German social market economy following World War Two. The doctrine, developed by Walter Eucken, quickly became associated with the 'Wirtschaftswunder' that saw Germany's meteoric rise to the third-largest economy (by GDP) in the world, following the 1989 collapse of the Berlin Wall.[9] Furthermore, additional government policies that could not otherwise have been created by private enterprises or weak states, supported the growth and industrialisation of the Asian Tigers from the 1960s onward. The government of South Korea, for example, attracted large TNCs (such as Sony) from Japan, introduced significant market reforms and devoted policies to technological development and innovation to promote its export competitiveness in the international market, which increased growth; between 1996 and 2015 their research and development intensity grew by 88.5%[10] while their GDP increased from $598.1bn in 1996 to $1.619trn in 2018.[11] These examples demonstrate how possessing a strong state can allow the government to adopt policies of economic interventionism, which historically have helped those countries industrialise and  specialise while reducing market failures. Subsequently, those countries have experienced an immense boost to economic growth.

 

It is worth considering that, by our earlier definition, China and the United States are both very strong states with large economies and yet both intervene in their economies at vastly different levels. This example reveals the subtle difference between how the strength of the state impacts growth and how government intervention impacts growth; the two are not perfectly aligned. Having taken this into account, however, it can be observed that a laissez-faire approach to the economy (which is how a weak state would handle their approach with little capacity to intervene) can still foster economic growth and thus demonstrating how a weak state could at least provide similar levels of growth to a strong one. Initially popularised by the French Physiocrats in the mid-1700s, laissez-faire policies were seen as a central part of free-market capitalism that focused on efficiency over equality in the markets. The economic boom experienced during the 'Roaring Twenties,' in the United States was spurred on by the pro-business attitudes of Warren Harding, Calvin Coolidge (who famously stated that "The business of America is business") and Herbert Hoover.[12] Under these Republican presidents, big businesses were allowed to expand, and the economy grew by 42% in the decade.[13] Laissez-faire policies were seen as a major contribution to this growth. It must not be forgotten, however, that this unregulated growth contributed to the Wall Street Crash, in October 1929, which plunged the United States into the Great Depression.

 

More recently, neoliberalism emerged under Ronald Reagan and Margret Thatcher and was championed by American economist Milton Friedman. Serving as the dominant economic ideology in the United States and the UK since the 1980s, it promoted privatisation, public spending cuts, and deregulation. The Chicago School of Economics and other groups believed that profit incentivised firms to increase productivity and become more competitive which would drive economic growth, while public sector spending would only ‘crowd out’ private enterprise. Meanwhile, the adoption of so-called ‘Reaganomics’ included the use of trickle-down economics which, according to the Laffer Curve, would boost growth and government revenue. The previous two examples show how further government intervention is not strictly necessary and that a state that does not intervene (possibly because it is a weak state) can still see economic growth. Regardless of to what extent these policies were a success, however, it might be noted that both of these examples stem from countries that are actually unequivocally strong. Therefore, although the real development of these two countries when applied to the hypothetical scenario shows how strong intervention is not strictly needed, the examples do not satisfy a positive correlation between the strength of the state and it's level of government intervention in the economy. A strong state will at least have the power to intervene, but it will not necessarily intervene: a strong state has the ability to choose whether to intervene or not to intervene, both of which can result in strong economic growth.

 

Empirical data and theories from recent developments in the global economy have revealed that a strong state is a prerequisite to economic growth. While the role of the government and the state in the economy is often a politically charged debate, by distinguishing between the state’s ability to intervene and its willingness, we can observe that governments to some extent need to interfere in the economy and that this intervention has been allowed by the very strength of that state. This strength, in turn, has permitted economic growth to occur across the developed world. Of course, the strength of a state can turn into an obstacle to growth if that government chooses to excessively manipulate the economy, but until such an occurrence, strength from an economic perspective only empowers growth.

 

Bibliography

Acemoglu, D. (2005). Politics and economics in weak and strong states. Journal of Monetary Economics, 1199-1226.

Amadeo, K. (2020). 1920s Economy: What Made the Twenties Roaring. Retrieved from The Balance: https://www.thebalance.com/roaring-twenties-4060511#:~:text=The%201920s%20is%20the%20decade,of%20being%20a%20global%20power.

Barnier, B. (2020). Neoliberalism. Retrieved from Investopedia: https://www.investopedia.com/terms/n/neoliberalism.asp

Calvin Coolidge. (n.d.). Retrieved from History Central: https://www.historycentral.com/Bio/presidents/coolidge.html

Demerit good definition. (n.d.). Retrieved from Economics Help: https://www.economicshelp.org/blog/glossary/demerit-goods/

Fukayama, F. (2011). The Origins of Political Order. Profile Books Ltd.

Government Intervention and Disequilibrium. (n.d.). Retrieved from Lumen Learning: https://courses.lumenlearning.com/boundless-economics/chapter/government-intervention-and-disequilibrium/

Harrison, M. (2003). How much did the Soviets really spend on defence? New evidence from the close of the Brezhnev era.

Hayek, F. (1962). The Constitution of Liberty. University of Chicago Press.

Hillier, D. (2007). Africa's Missing Billions: International arms flows and the cost of conflict. Oxfam.

IMF, I. M. (2019). Retrieved from Online Annex - The Economic Consequences of Conflicts: https://www.imf.org/~/media/Files/Publications/

Johnston, M. (2019, December). Why the USSR Collapsed Economically. Retrieved from Investopedia: https://www.investopedia.com/articles/investing/021716/why-ussr-collapsed-economically.asp

Kishtainy, N., & George, A. (2012). The Economics Book: Big Ideas Simply Explained. Dorling Kindersley.

Mankiw, N. G. (2016). Principles of Economics Eigth Edition. Cengage Learning.

Maria, A., & Zhu, H. (2018, March). How Did South Korea’s Economy Develop So Quickly? Retrieved from Federal Reserve Bank of St.Louis: https://www.stlouisfed.org/on-the-economy/2018/march/how-south-korea-economy-develop-quickly#:~:text=Second%2C%20South%20Korea%20has%20devoted,rise%20over%20the%20past%20decades.

Mises, L. v. (1920). Economic Claculation in the Socialist Commonwealth.

Murphy, R. P. (n.d.). The Depression .

Negative effects of government intervention. (2019, May). Retrieved from The Star: https://www.thestar.com.my/opinion/letters/2019/05/22/negative-effects-of-government-intervention

Pettinger, T. (2020, April). Should the government intervene in the economy? Retrieved from Economics Help: https://www.economicshelp.org/blog/5735/economics/should-the-government-intervene-in-the-economy/

Raanes, B. (2019). In Light of Yesterday: The Backstory of the Global Economy.

Roser, M. (2013). Economic Growth. Retrieved from Our World in Data: https://ourworldindata.org/economic-growth

Salsman, R. M. (2013, September). The Financial Crisis Was A Failure Of Government, Not Free Markets. Retrieved from Forbes: https://www.forbes.com/sites/richardsalsman/2013/09/19/the-financial-crisis-was-a-failure-of-government-not-free-markets/

Weber, M. (1919, July). Politics as a Vocation.

World Development Indicators. (n.d.). Retrieved from The World Bank: http://datatopics.worldbank.org/world-development-indicators/

Wren-Lewis, S. (2014, January). Ordoliberalism, Neoliberalism And Economics. Retrieved from Social Europe: https://www.socialeurope.eu/ordoliberalism-neoliberalism-economics

 


[1] Other metrics that the state may influence, such as the Human Development Index and levels of political freedom, will be ignored.

[2] (Fukayama, 2011)

[3] (Hayek, 1962)

[4] (Weber, 1919)

[5] (Hillier, 2007)

[6] See Figure 2.41 below (IMF, 2019)

[7] (Mises, 1920)

[8]  (Harrison, 2003)

[9] (Roser, 2013)

[10] (Maria & Zhu, 2018)

[11] (World Development Indicators, n.d.)

[12] (Calvin Coolidge, n.d.)

[13] (Amadeo, 2020)

Log in to post a comment: