Postcrisis: A new role for the state

Credit: Associated Press

May 04, 2020

Sections Public Policy Video

Collections COVID-19 Crisis

In the videocast Capitalism after Coronavirus, Chicago Booth visiting professor Luis Garicano, a member of the European Parliament, spoke with Booth’s Luigi Zingales about the current and future role of government—and the new world order.

Garicano: You wrote recently a tough editorial in the Financial Times about Europe. You said, “The EU is playing with fire. It’s Europe’s last chance. Either the EU shows itself willing to provide substantial help to member states in trouble, or it has no reason to exist.” Do you really think this is the last chance for Europe?

Zingales: Absolutely. I think that tension is growing, especially in my home country [Italy]. There was a lot of dissatisfaction with Europe before, but now the situation is so grave that if the EU doesn’t take fast and bold action, Italians will reject Europe. Many people think there are no alternatives, but alternatives exist. Italy could become an ally of China, for example. 

Garicano: This point you raise is new and shocking. In the past, we’ve had leaders who have played a pretty tough game with Europe, and in the end, they didn’t really have any bargaining power because they didn’t have alternatives. Now you’re telling us you really think it’s a credible threat for Italy to throw itself into the hands of China and make a massive strategic shift. 

Zingales: China is playing the game beautifully in the absence of American and European leadership. At a moment when people in Italy were questioning Europe, China sent a team of doctors and ventilators. 

My parents’ generation grew up with an image of the American dream liberating the country, and I grew up with that image in my mind. Unfortunately, President Donald Trump does not portray that image around the world. For the new generation, China in many respects is more similar to Italy than the United States [in that] we both have family values and long-term cultures.

Garicano: This would be a massive defeat for Europe, and I hope I can help prevent that and make Europe take the action that it needs to take.

But let’s shift to the changes to capitalism that we expect as a result of the coronavirus. There are two main issues: one is the role of the state, and one is the role of globalization. Many people say liberalism has seen its best days. [Philosopher] John Gray recently wrote [in the New Statesman]:

The era of peak globalization is over. Any economic system that relied on worldwide production and long supply chains is morphing into one that will be less interconnected. A way of life driven by unceasing mobility is shuddering to a stop. Our lives are going to be more physically constrained and more virtual than they were. A more fragmented world is coming into being that in some ways will be more resilient.

Do you agree? Are we going to see a big role for the state in the future, and are we going to see a change in globalization? Are we going to see a return of the nation-state?

Zingales: Certainly the role of the state will become much more important. Most people have not seen a market failure of this proportion. You can argue that global warming is in that direction, but with the pandemic, we saw it right away, and we saw that governments such as Taiwan that intervened right away have economies that are still functioning. But a government that acted like the US caused an economic disaster.

This suggests that the government, and what I call government capacity or government effectiveness, is extremely important in the response to pandemics, and I would say in development as well. Market economists underplay the role of the government. But which country has really succeeded with a weak government? I don’t think you’ll find one. All the big capitalist success stories are those with a strong government capacity. A vein that needs to be fought is the idea of minimizing the role of the state.

Garicano: One huge concern is the idea of crony capitalism. As the role of the state grows, we get more institutions in which prices don’t rule and allocations are made by friends, by cronies. This has been the main concern in market-oriented economies. If the state grows larger, how are we going to avoid the crony capitalism and corruption that grow with it?

Zingales: I completely agree, but before talking about size, we need to talk about the effectiveness and capacity of the government. American libertarians want to minimize the government, its power, and the problems they think stem from that power.

That doesn’t work because we need the state. This pandemic is an example. Compare the effectiveness of the response of Switzerland or Denmark with the US response. The US is throwing money at the problem with no ability to target the solution because it doesn’t have an effective bureaucracy. I don’t like bureaucracy. I would like to live in a world in which we don’t need it, but I’m also a realist. We do need it, and when we need it, it’s better to have a bureaucracy that works.

Once you go down that path, the first question is how to create an institution with a better chance of not adding all these deviations. For many years, one solution was to minimize the role of the state. That was the wrong answer because of the difference between the discretionary role and the automatic role of the state. 

Consider universal basic income. I’m not in favor, but if you implement a policy such as that, where everyone gets $1,000 per month, that’s not discretionary. If there is a policy that introduces help only if you can show that you are a strategic industry and you are really suffering, that creates all sorts of discretion.

The first policy clearly requires an effective government. But it’s possible to have government intervention without bringing in so many cronies. You need to have more universal and noncontingent rules.

Garicano: There was a famous Spanish economics minister who said the best industrial policy is the one that doesn’t exist. His view was to just let the market work. What we now find with masks and medical supplies is that certain things are actually necessary to survive. Letting a whole globalized system of production decide that all your food is going to be grown on another continent might be a problem. So we might start thinking that supply chains need to be brought home for items such as masks, but why not for food? Why not energy? If we talk this way, we are just a step away from picking winners, from having well-connected industrialists who managed to get help because they were strategic. What is your view in this particular case of industrial policy and strategic supplies?

Zingales: Globalization took place only two times in history, and during those times, there was a hegemonic power that was maintaining order. The first was under the British Empire, which enforced a number of rules that made that [globalization] possible. The second was under American power. In the past, the reason nobody would dare to say, “I won’t send you the masks,” is because the president of the US would pick up the phone and say, “If you want to belong to this community, you’ll have to play by the rules.”

So we need to have some global institutions that take this stance. This is where Europe has failed massively. When European states block the export of material to other European countries, this becomes an existential crisis. If Europe does not rise to the occasion now, there is no reason for it to exist.

Garicano: I agree. But still, even if we had managed to get a single market to work, my question would remain. Do we really think that we have the concept of strategic supplies? Are there certain industries that Europe or the US needs to have? That’s something that Trump would have said three or four years ago, and it would have been shocking, but maybe now we have to accept that some supply chains have to be local, or that there are industries where the state decides things cannot be exported or imported.

Zingales: It depends on geopolitical alliances. Italy has never thought about having a strategic reserve of oil because we rely on allies that will supply oil in the case of need. If you do not trust those allies, you have to make strategic choices. 

Trump told 3M to produce masks and only sell them to the US, but 3M pushed back because it wants to trade globally. The moment Canada cannot rely on the US as an ally, Canada has to build that strategic industry for basic things. That will quickly create a much less globalized economy. 

Garicano: The welfare costs of that are massive. If we start thinking that any state needs to be self-sufficient on a large range of things, trade is going to be substantially reduced.

Zingales: The welfare costs are huge, but what is worse is the risk of war. That strategy pretty quickly goes the way of war, because if I don’t have guaranteed access to something I need to survive, I will need to have control over it. That’s what colonialism was about. The fights that led to World Wars I and II were about exactly this.

After the fall of the Berlin Wall, we created a new world order, and that guaranteed a different world, the world we live in. Now China is a superpower that plays by different rules and does not reassure us in the same way that the US reassured us. I don’t know whether that’s a consequence of China behaving this way, or the idiosyncrasies of President Trump, or a combination of the two, but the US has started to behave differently. Even before the COVID-19 crisis exploded, we were already going down a bad path.

Garicano: What’s the path back? For Europe, it would be more or less something close to a fiscal union. We need to have a package to help the nations in need and to recover the role of Europe. Is there a path back for the world?

Zingales: I’m a bit skeptical because I see the China-US tension as inevitable and dangerous. Culturally, they don’t understand each other. China’s perspective is, “We have always been the center of the world.” They want a dominant position at the table.

Americans have grown up for generations thinking that they are the dominant force. They’re certainly not going to be prepared to concede dominance to China. This is a major cultural clash. We desperately need a united Europe. Each of our individual countries of origin are nonexistent, in a sense, if we don’t have Europe. We are little peons in the big war.

Garicano: One thing that is always talked about in this context is this idea of a different model of capitalism in Asia—in Taiwan, Singapore, China, Hong Kong, and Japan—in which the state plays a much more central role, in which businesses in these states are not really separate. Do you think we’re going to move toward that form of capitalism? 

Zingales: That’s certainly a risk. My hope is that we can develop a different form of a state and capitalism. If you think about the way Denmark, Sweden, and Norway work, they are much more promarket than the US in many sectors. But they do have a pretty efficient government, and a good one for systems. The future of a state without an effective government is nonexistent. The choice is between state capitalism and capitalism with an effective state. I much prefer the latter to the former.

Let me leave you with a positive. I see this as a massive moment of transformation. Digitalization is being pushed down the throats of people in a way that would be unbelievable before, but this has moved the economy forward by 20 years. That will generate an enormous amount of ideas, innovation, creation. I hope that this pandemic will show us what can happen with climate change. I see this crisis as a sign of what can happen if we don’t act. 

This is an edited version of a conversation that first appeared on Booth’s Stigler Center’s ProMarket blog.

Luis Garicano, on leave of absence from IE Business School, is a member of the European Parliament. Luigi Zingales is the Robert C. McCormack Distinguished Service Professor of Entrepreneurship and Finance and a Charles M. Harper Faculty Fellow at Chicago Booth.