Cyprus Mail

A smaller, stronger state

By Theodore Panayotou

THE CORE activities of the state are defence of the country, maintenance of the law and order, guarantee of property rights, enforcement of contracts, maintenance of competition, correction of market failures, alleviation of poverty and macroeconomic and financial stability.

Many states, including ours, have been dissatisfied with this limited but pivotal role and gradually extended themselves in just about every aspect of economic and social activity. The state has increasingly entered areas where it has neither a clear role nor a comparative advantage.

The spread of the state and its limited resources too thin resulted in “the dereliction of attention to its core activities” (World Development Report 1997) or as Vito Tanzi of the IMF argued “the state has been doing more and more and doing it less and less well”.

The state has distorted incentives and markets, created a skewed playing field, encouraged crony capitalism, patron-client relationships between citizens and political parties, rent-seeking and corruption and ultimately reduced the competitiveness of the economy and the welfare of the people.

The  55-year history of the Cyprus republic all point to a state that failed on its core activities. On the defence front, the state has been unable to defend its territorial integrity, having lost over a third of its territory, and is now unable to deter violations of its exclusive economic zone.

On the law and order front, it has done better for a while but now, with open borders and a multicultural population, a growing feeling of insecurity is taking hold among the citizenry and visitors alike. As to the guaranteeing of property rights and enforcement of contracts, the state has not done well (property titles and judicial decisions take years) and in many cases the state has been itself a major violator of property rights and contracts.

The pre-EU era was characterised by monopolies and oligopolies which were justified on the basis of the smallness of the market and the need to protect infant industries.

But, even with the country’s entry into the EU and the Eurozone and the increased openness of the economy, oligopolies and cartels, ranging from fuel imports to banking, continue to thrive. The Competition Commission has been the least successful of the EU-imposed institutions.

Even the macroeconomic and financial stability which has been the single indisputable accomplishment of the state came crashing down and, with it, the veneer of prosperity, when the state failed to control its spending and to ensure the integrity of the financial institutions and the oversight authority.

The delay and ultimate abdication of the role of the state in taking measures to avert the economic and financial disaster has led to the collapse of the country’s thriving financial system, the loss of many people’s lifetime savings and a quarter of the country’s wealth.

If the state had managed to avert the banking disaster, the pervasive corruption and its own mismanagement of public finances, it would have made a far greater contribution to economic and social welfare than the very mixed record that it has to show now by getting involved in just about everything. For that to have been achieved, less but stricter regulation and more objective and consistent enforcement would have been needed.

The failures of the market, far from being corrected, have been exacerbated by allowing crony capitalism and corruption to flourish. Despite supposedly competitive, impartial and unimpeachable public tendering procedures, bribes and kickbacks have been pervasive especially within the state enterprises and local government.

Clearly, the state has lost sight of its role and failed in performing its core activities. The role of the state needs to be clearly defined and effectively executed. When the state sees itself as the solution to most problems, the state itself becomes the problem. What we need is a smaller and stronger state.

Political parties and politicians prefer a bigger and weaker state, with more extensive and complex regulations loosely enforced, because this gives them a bigger role and more opportunities to manipulate the state in their favour.

With the steadily expanding role of the state and the piling up of regulations and bureaucratic procedures, we lost sight of the forest for the trees. Selective reforms of public administration and the elimination or consolidation of a few government units here and there will not bring the desired results.

We need to rethink the new role of the state in a world of rapidly advancing technology, instant communication, free-flowing information, capital and labour mobility, globalisation and global competition. In the new world the old structures will not do.

The state should focus first and foremost on its core activities mentioned in the introduction. The rest should be left to the private sector operating under clearly defined and strictly enforced rules.

In this new world, the state must play a stronger and more intelligent regulatory role leaving the provision of infrastructure and services (traditionally provided by public utilities, or state institutions as in health and education) to a properly and effectively regulated private sector.

We need more and better supervision and less provision. We need clear rules, fairly and consistently enforced. We need intelligent regulation which is enabling not disabling. We need simplification and streamlining of procedures, elimination of red tape and bureaucracy, and the adoption of up-to-date technology.

A few examples will suffice. A big part of the expanded role of the state was based on the idea that certain services (e.g. electricity and telephony) are “natural monopolies” which are better provided by a state than a private monopoly. Technological advances have reduced the genuine monopoly part (distribution infrastructure) and opened up the rest (production) to competition, and hence reduced the state’s role in provision yet increased it in regulation.

Another part of the expanded role of the state was based on imperfect information flows and information asymmetries among economic agents which justified the provision and diffusion of information by the state to the public for better and fairer functioning of markets.

Technological advances and the information revolution have made information widely available and instantly accessible far beyond the reach of even the most informed and efficient state.

Another traditional role of the government that needs rethinking is its role in income distribution. It is true that, while good at allocating resources, markets are not good at distributing income the way society might want it distributed. While this creates a role for the state, unfocused and untargeted policies such as price controls, general subsidies and free health and education are very costly, create perverse incentives and tend to benefit the middle class more than the poor.

Experience and research have shown that economic growth, job creation and interventions targeted at the truly poor are more efficient and effective treatments of poverty.

Picking winners and promoting them with government support is another popular but misguided role for the state. The assumption is that the state knows better than the private sector how markets work, how investors think, what customers want, and what people need most. This is, of course, rarely the case. Industrial policy has been the example par excellence, but picking winners and providing them with “temporary” support and protection has been a favourite policy of governments pursuing economic recovery and growth as well. The chances are that the wrong industries are selected which rarely outgrow the state support and establish a genuine competitive position in global markets.

The state should, instead, promote the general competitiveness of the economy by reducing the cost of doing business across the board through intelligent regulation, the removal of bureaucratic obstacles, the simplification of the approval processes, the establishment of clear and fair rules of the game, the strengthening of institutions, the provision of infrastructure and the openness of the economy.

This approach would attract the right kind of investors in the right industries to serve the right markets resulting in faster recovery and growth.

At any given point in time the role of the state is determined to a large extent by the legacy of past decisions and accumulated body of laws, regulations and practices. The most difficult problem in reforming the state is in dealing with the vested interests created by the status quo under an expanded and weak state.

The beneficiaries of the status quo in both the public and the private sectors, and especially in the political system, will fight tooth and nail any reform effort that aims at a smaller but more effective and efficient state, because they do not want to surrender these benefits. They will use power, political connections, populism, the unions and the financial resources at their disposal to kill any effort at real reform that will curtail their privileges.

The challenge for genuine reformers of the state is to find those reforms that are seemingly innocuous but contain in them the dynamics of catalytic change. Take for example the contentious issue of promotion of civil servants: should it be done based on seniority, examinations, performance evaluation (by whom) or the current system which is ridden with political interference? Making heads of departments and units within the civil service personally responsible for the outcomes of their units and giving them a big say in promotions of their personnel will result in both higher performance and more fairness compared with the current system.

Dr Theodore Panayotou, 2007 Nobel Peace Prize Contributor, is professor of economics and ethics and director of the Cyprus International Institute of Management (CIIM). He taught economics for 25 years at Harvard University, served as senior economist at the Rockefeller Foundation and advised presidents and premiers in 15 countries including China, Mexico, Russia and the USA. He has published over 100 books, monographs and peer-review articles. Contact: [email protected]

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