Toward a Modern State
“I don’t want to live in the world you describe.”
—Anonymous panel comment at the presentation of Laffont’s report
Paris, December 1999: Jean-Jacques Laffont, the best-known French economist of his generation, presented his report1 on the pathway to a modern state to the Council of Economic Analysis. It had been two years since Prime Minister Lionel Jospin created this advisory Council, an iconoclastic act in a country where economists are regarded with great suspicion. The response? Laffont’s balanced report was deemed heretical by the audience of senior officials, academics, and politicians. There was a general outcry, along with a series of speeches congratulating Laffont on his “remarkable report,” all the better to explain that he had understood nothing—or, worse still, that he was likely to corrupt French youth.
What did this report say? That politicians and officials respond to the incentives they face—just like CEOs, employees, the unemployed, intellectuals, or … economists—and that the way government is organized should take this reality into account. Despite having an original and profound mind, Jean-Jacques Laffont did not in this regard show a great deal of creativity. The possibility that the state can be captured by special interests at the expense of the collective interest, and that in a democratic system the desire to be elected or reelected may take priority over any other concern, has been at the foundation of all political thought, from Montesquieu to the Founding Fathers of the American constitution, including all the great constitutionalists, and even Karl Marx.
Laffont was deeply concerned with the public interest.2 He was not accusing government officials. He understood that many politicians begin their careers as idealists, eager to make the world a better place. He also knew that condemning politicians is dangerous for democracies, and should be left to populist parties and demagogues. But he triggered a wave of protests simply by suggesting that France’s leaders might, like everyone else, act in their own interest. Challenging the benevolence of the state touched a raw nerve for those commenting on his report that day.
Most of us throughout the world live in a market economy, with a greater or lesser degree of state intervention. We may like, tolerate, or hate this way of organizing society, but we don’t constantly ask ourselves whether other systems might be possible. Following the almost total economic, cultural, social, and environmental failure of planned economies, in regards to the market we observe or experience a kind of fatalism, for some spiced with indignation. The French feel particularly disoriented, as they are perhaps more distrustful than any other nationality of the market and competition.
Some of those who want change envision a vague alternative in which the market would no longer be central to society; others, on the contrary, favor a minimalist state that would make laws and dispense justice, maintain order and conduct national defense, the minimum functions necessary to enforce contracts and property rights necessary for free enterprise. Neither of these two approaches help deliver the common good. In this chapter we will try to understand why this is, and will explore a different concept of the state that could reestablish faith in the system that governs our lives.
Reflecting on the role of the state requires identifying both the problems the market poses for the proper functioning of our society, and the limits of state intervention. We will therefore step back a bit and examine the logic behind the way our society has been constructed. Next, we will show that the market and the state are complementary—not substitutes for one another, as the public debate often implies. Then we will discuss the primacy of politics, and its loss of influence. Finally, we will take up the sensitive subject of how to reform the state. While reasonable people can disagree on the desirable size of the state - more taxes, redistribution and public goods or less of these - all would rightly object to a bloated public sector providing a mediocre-quality public service; and yet reforms to improve public sector performance are often fraught with difficulty, which raises the issue of how to go about implementing such reforms.
THE MARKET HAS MANY DEFECTS THAT MUST BE CORRECTED
Supporters of the market emphasize its efficiency and integrity. By efficiency, they mean the way free competition forces businesses to innovate and offer consumers goods and services at reasonable prices. This improves households’ buying power, which is particularly important for the middle classes and for those with low incomes.
Market integrity is more abstract, but no less important. Just as political and cultural freedom protects the minority against oppression by the majority, freedom of enterprise and commerce protects citizens against interest groups who wish to use the political system to obtain privileges at the expense of the rest of us.
A comparison of standards of living in planned and market economies at the time of the fall of the Berlin Wall in 1989 (or of South Korea’s living standard today, more than ten times higher than North Korea’s) leaves little doubt as to the benefits of economic freedom. But we know the market is not perfect, and this book deals with numerous “market failures.” To think about these failures, we can ask a simple question: How might a mutually agreed upon exchange between a seller and a buyer pose a problem for society? This exchange must assuredly benefit both parties if they decide to engage in it. So why interfere?
Market failures can be divided into six categories:
1. The exchange can affect third parties, who are, by definition, not consenting. For instance, businesses can pollute their environment when they manufacture the product they are selling to consumers. An energy company producing electricity in a coal-fired plant emits greenhouse gases such as carbon dioxide, and pollutants (sulfur dioxide, nitrogen oxide) that generate acid rain. There is no market mechanism for protecting those who passively suffer this harm. As a result, society has to cope with air polluted with fine particulates, sulfur dioxide, and greenhouse gases, and water tables, rivers, and seas contaminated by fertilizers and chemical spills. Thus, the market needs to be complemented by an environmental policy or, in another domain, a nuclear safety authority.
2. The exchange may not take place with full knowledge and consent. For a trade to be carefully considered and consenting, the buyer must be properly informed. But the buyer may not know how dangerous a drug or another product might be, or may not be enough of an expert to avoid being cheated. That is why we need a consumer protection authority regulating business and punishing fraud. It may also be that the exchange has taken place under duress (for instance, a threat of physical violence) or that it involves the assets of a person who is not competent to manage them, which is clearly problematic.
3. Buyers can become victims of their own actions. People may lack self-control and act impulsively.3 Since the dawn of time (for economists, that is, since Adam Smith), philosophers, psychologists, and economists have emphasized the possibility that people may have an excessive preference for the present for their own sake. They may put too little weight on their own future when they consume something now. This is the justification for taxing cigarettes or fatty or sugary goods, limiting access to drugs, or requiring a cooling-off period for certain purchases of durable goods or financial services in order to protect consumers against themselves (or similarly against door-to-door salesmen to whom people might give in just to get rid of them). It is also the argument invoked in many countries to force or encourage individuals to contribute to retirement pensions (in countries with funded pension schemes) or even to use payroll taxes levied on active workers to pay for the pensions of those who have already retired (for countries with pay-as-you-go pensions). The underlying idea is that people are preoccupied by their immediate well-being and don’t think or care enough about their long-term future. The shortcomings of the paternalistic argument are clear (the state cannot infantilize us and decide too often what is good for us!), but the individual’s understanding that he or she may lack willpower is a potential benchmark for determining when the state can substitute itself for personal judgment.
4. Implementing the exchange may exceed the individual’s capacities. When you put your money in the bank, contract terms specify the conditions under which you can withdraw your deposit (anytime in the case of sight deposits). Similarly, your insurance policy stipulates that you can receive a benefit in the event of an accident or fire, and your investment in a life insurance policy or investment account gives you the right to an income (guaranteed or not). But there is the risk that on the day that you want to withdraw your deposit or receive your insurance payout, the bank or the insurance company may have declared bankruptcy, leaving you paying out of pocket. Of course, in theory you could continuously monitor a financial institution’s on- and off-balance sheet activities in order to detect an impending failure and withdraw your savings or cancel your insurance policy in time, but there are obvious limits to how well you could do this. It takes time to find the information, and technical expertise to draw conclusions from it. In practice, in every country a banking supervisor and an insurance regulator spare you this effort.
5. Businesses can have market power—that is, an ability to make consumers pay prices far above costs, or to get away with mediocre products. This is especially the case when markets are monopolized, for example when there are substantial returns to scale. Market power is the rationale for competition law and sectoral regulation, and most countries have a number of bodies regulating it. Thus, in the UK the Competition and Markets Authority enforces both consumer protection and competition laws, and there are other regulatory bodies for communications, railroads, and energy. In the United States, the Federal Trade Commission, the Department of Justice, and sectoral regulators such as the Federal Communications Commission or the Federal Energy Regulatory Commission have similar responsibilities.
6. Finally, although the market improves efficiency, there is no reason it will deliver equity. Let’s take the example of health care: if private health insurance companies or the national healthcare system were allowed to discriminate between individuals, for instance on the basis of genetic data or the person’s current state of health, someone with cancer or genes indicating potential health problems could not obtain medical insurance at an affordable price. This is an old theme in economics: information kills insurance. That is why in many countries, the law prohibits conditioning medical insurance fees to information regarding the individual concerned.
Similarly, there is no reason the market will lead to a socially desirable distribution of incomes. Inequality is expensive for two reasons, one connected with justice and one with efficiency. In a market economy, inequality might be viewed as no more than a failure of insurance. “Behind the veil of ignorance” (that is, before we know anything about our own future) we would want to reward effort to incentivize people to create wealth for society, but we would also want to ensure that we would be able to live in decent conditions if we have the bad luck to be among the most unfortunate. In this sense, the social contract can be seen simply as an insurance policy. This is the foundation for redistribution through the tax system. In sum, there is no reason why access to insurance and the distribution of the income and wealth created by the market corresponds to what people would want behind the veil of ignorance, before knowing their place in society.
Moreover, in addition to this “destiny risk” (as one might describe it), inequality can also be dysfunctional.4 It distorts social bonds and so can create externalities from which the whole population suffers, including those who have prospered because of their work or background. These externalities include civil insecurity, ghettos, and groups vulnerable to radicalization. The disturbing sight of gated communities shows clearly that the negative effects of inequality cannot be summed up simply as a failure of insurance against “destiny risk.”
THE COMPLEMENTARITY BETWEEN THE MARKET AND THE STATE AND THE FOUNDATIONS OF LIBERALISM
Public debate often pits advocates of the market against advocates of the state. Both parties assume the market and the state compete. And yet, the state cannot ensure its citizens a (decent) life without a market; and the market equally needs the state to protect free enterprise, to guarantee contracts through the judicial system, and to correct market failures.
The organization of society is traditionally (and implicitly) based on two foundations. The first, the invisible hand of the competitive market, described in 1776 by Adam Smith in The Wealth of Nations, uses the pursuit of self-interest to achieve economic efficiency. The idea is that the price of a good or service, which results from matching supply and demand, encapsulates a lot of information: the buyer’s willingness to pay and the seller’s cost. In fact, an exchange occurs only if the price the buyer is willing to pay matches or exceeds the price he is asked to pay; similarly, the seller will agree to sell only if the price he receives exceeds his production cost. Putting these two observations together, the buyer will purchase only if he is prepared to pay more than the seller’s production cost. In a competitive market, buyers and sellers are too small to manipulate prices; if the market is in equilibrium, the price is such that the demand at this price is equal to the supply at this price. All the possible gains from trade are realized.5 The result is an efficient social allocation of resources.
The second foundation is that the state corrects the many market failures just spelled out. It makes economic agents accountable for the consequences their choices have for others and is responsible for social cohesion. The classical liberal approach is to leave the greatest possible number of economic decisions to individuals and firms, not the state, so as to make use of decentralized information; but for this to work, individuals and firms must be held accountable for the consequences of their decisions for society. One of the clearest defenders of this idea was the English economist Arthur Pigou (Keynes’s professor at Cambridge), who in 1920 introduced the “polluter pays” principle in his book The Economics of Welfare.
I would like to emphasize the coherence of this framework before going on to analyze its limits: the state defines the rules of the game and the agents’ responsibilities; they then may (and even must!) pursue their own self-interest. Take the case of the environment: instead of the state deciding which businesses must decrease their pollution (which it can only do blindly because it lacks the necessary information), it might say: “If you emit a ton of CO2, you will be charged fifty dollars. You decide.” Having been made responsible for the impact of its choices, the firm can concentrate on producing efficiently while meeting the constraints that society wishes to impose on CO2 emissions.
Taken together, Smith’s and Pigou’s work is the foundation for shareholder value and for liberalism, but for a kind of shareholder value and liberalism that differ from their common interpretations. Economic liberalism tends to be identified with an absence of state intervention and with the individual struggle for survival. But on the contrary, the keystone of the edifice is that agents must be responsible for the social cost of their choices.
FAILURES OF THE STATE
This analysis shows that the market and the state are not alternatives but, on the contrary, are mutually dependent. The proper functioning of the market depends on the proper functioning of the state. Conversely, a defective state can neither contribute to the market’s efficiency nor offer an alternative to it. Like markets, however, the state often fails. There are many reasons for these failures. Regulatory capture is one of them. We are well aware of the friendships and mutual support that create complicity between a public body and those who are supposed to be regulating it (witness the revolving door through which politicians and civil servants obtain jobs in the firms they once regulated). But this is only a small part of the equation. The essence of political motivation is the desire to be elected or reelected, and this can distort decision making in two ways.
First, there is a temptation to exploit the prejudices and lack of knowledge of the electorate; we shall return to this subject later. Second, the costs of policies advocated by a hypermobilized pressure group are often not obvious to the rest of society (for example, to taxpayers and consumers), although their benefits are very clear to the group. This asymmetry of information, sometimes reinforced by a deliberate choice to obscure the favors,6 distorts public choice. An important example of a policy whose benefits are more visible to the beneficiaries than the costs are visible to others is the job-creating clientelism often practiced by local and regional authorities, which leads to them becoming excessively large.
Making political action responsive to the public interest is complex. Electoral sanctions work in some domains, but not in others. For instance, the failure of a public transport system is very visible. But borrowing by state and local authorities (and especially its off-balance sheet forms aiming to disguise the debts), along with inefficient public sector job creation (creating, de facto, another long-term debt in the form of their life-long salaries, also off-balance sheet) are far less visible to the electorate.
To return to a point made in the introduction to this chapter: those who criticize politicians should first reflect on what they would do, in the politicians’ shoes. Understanding the implications of this analysis instead of assuming that the failures of the state are just the failures of the individuals involved (even if politicians actually do differ in courage and quality of management), might discourage us from moralizing, or being too eager to condemn the entire political class.
Finally, market failures cannot always be effectively corrected due to the geographic limitations of particular jurisdictions: governments cannot make policies for other countries. Without an international agreement, regulation must be national. While any country can encourage its businesses, its citizens, and its administrations to reduce CO2 emissions or prohibit child labor,7 it can do little to regulate such activities in other countries.
POLITICIANS OR TECHNOCRATS?
It is not enough to insist that state intervention is necessary; we must also address how to organize it. In many countries, there are few subjects as sensitive as the division of labor between elected decision makers and independent administrative bodies run by administrators or technocrats. This tension between accountability and independence is universal, and has been manifesting itself in populist attacks on “expertise” in a number of countries, including the United States, the United Kingdom, and France.
Independence from political power is certainly not a new idea (for example, the independence of judges from the British crown dates from the Act of Settlement of 1701,8 and the separation of powers is written into the 1787 American Constitution). But the reforms carried out over the past thirty years and the attacks on independent administrative authorities in France, or the recent verbal attacks by politicians on the independence of the judiciary in Britain and America, or on central bank independence around the world, mean we must revisit its foundations.
The independence of judges in a healthy democracy is a good illustration of a fundamental point: the setting of objectives belongs to the domain of politics and societal decision making. But however society defines “justice,” its impartial application is best guaranteed by independent judges. The same goes for decision making in economic policy. Economics is a science of the means, not of the ends. Consequently, an independent authority should be trusted with a general mandate within which it can evaluate options and find technical solutions, a mandate that guarantees coherence in that authority’s policies and its independence with regard to pressure groups.
THE NEED FOR INDEPENDENT AUTHORITIES
I repeat: It is unproductive and irresponsible to blame politicians for the limits of political action. Instead, it is important to realize that politicians, like all of us, react to the incentives they face.
In the case of politicians, the incentives are strongly influenced by the need to be elected or reelected. This has the advantage of forcing elected officials to take public opinion into account. This benefit, however, is also the Achilles’ heel of the democratic mechanism. While the goal of representative democracy is to delegate decision making to people who are better informed than the electorate, these are often transformed into pollsters who exist to follow public opinion, or at least public opinion as shaped by the media. Many prefer not to sacrifice their political careers by embracing a cause that is generally unpopular or would raise objections from special interest groups. Sometimes a politician dares to be clear sighted and ignores public opinion. For example, François Mitterrand’s abolition of capital punishment in France in September of 1981 went against majority opinion. However, the personal risk was diminished by the fact that Mitterrand was at the very beginning of his first seven-year term (voters have noticeably short memories). Besides, the fact that this act of political courage struck many observers of French politics only confirms my point that such behavior is the exception rather than the rule. An American example of a courageous-because-unpopular policy choice is the Affordable Care Act (Obamacare), for which (according to some polls) the margin between those against and those in favor was about 10 percent between 2010 and 2016.
Independence can be viewed as a reaction to the derailing of regulatory decisions to further electoral goals. All over the world central banks have gained independence as a result of politicians’ habit of “pump priming”—increasing public spending before an election to create a short-run boom while triggering future inflation, to the detriment of the long-run health of the economy. Telecommunications, energy, and other network industries generally also have independent regulators (government agencies and, in some countries, judges). The motivation for independent sector regulation is the political temptation, when a minister is the regulator, to keep prices artificially low. This compromises investment and the viability of long-term networks (consider how often elected representatives call for lower prices for electricity and gas).
The devolution of competition policy and sectoral regulation to independent authorities also reflects the ministries’ desire to avoid conflict with the management and employees of politically sensitive industries, who obviously see their sector as a private preserve and want to avoid, at any cost, the introduction or increase of competition. For example, the abuse of a dominant position or a merger endangering competition in a market used to involve closed-door discussions with a government official. The terrain was political, and the outcome depended as much on personal relationships as it did on the economic validity of the argument. The shift of the application of competition law to independent authorities has completely changed the game. There is little room for backroom deals, and all parties involved must have solid arguments and facts. Economic reasoning plays a much greater part. I am not always in agreement with the decisions these authorities make, but that is not the point. The guidelines and hearings are subject to debates that bring out the merits of the arguments rather than power relationships: the decisions made are of a higher quality than before. If we want to improve the quality of the decisions these authorities make, it is up to us as economists to improve our research and do a better job of explaining it, and it is up to the regulatory authorities to continue to sharpen their analyses.
Another example shows the dangers of politicization: the crises in banking (and sometimes even sovereign debt) caused by the real estate market. In countries all over the world, political leaders from the conservative George W. Bush to the socialist José Luis Zapatero have sought to increase home ownership. There is nothing wrong with this, in theory. In practice, policies encouraging individuals to buy homes have included a relaxation of the criteria for financial institutions to grant real estate loans. Loans were made to households that were barely solvent, and when they hit either personal problems or macroeconomic problems (such as a rise in interest rates or a decline in housing prices), they were unable to make their loan payments and were evicted. Undercapitalized banks had to be rescued by the state.
Much has been written about the subprime crisis, which involved these very risky real estate loans in the United States and many other countries. Until 2008, Spain experienced a real estate bubble that, when it burst, had terrible consequences for borrowers, the construction sector, savings banks, and the Spanish people in general. Bailing out the banks increased its national debt (which was low, below 40 percent of GDP before the crisis) and damaged the economy to the extent that Spain had to ask the IMF, the ECB, and the European Union for financial help. Spain seesawed between austerity and plans to jump-start the economy. Unemployment rose quickly, particularly among young people, and the crisis had a high social cost.
The fragility of the banks was therefore a decisive factor in the crisis in Spain. Suppose I told you that the Spanish banking supervisors were among the most qualified in the world, according to their peers? These supervisors had identified early, around 2005, the risks the real estate bubble posed for banks. They were the first in the world to require banks to maintain additional reserves during prosperous times (one can only imagine what the Spanish crisis might have been like had they not). This anticipated the reforms adopted within the Basel framework9 after the crisis, which introduced the requirement for banks to increase their capital in good times. However, once the central bank had diagnosed the problem in 2005, the decision about whether to force the banks to reduce their real estate exposure was in the hands of Spanish politicians. Their desire to please won out over regulatory prudence.
INCREASE THE PRIMACY OF POLITICS?
When should decision-making power be granted to politicians? In theory, the political process seems more appropriate for making the societal choices understandable to the electorate as a whole (on the condition, of course, that the majority does not threaten to oppress the minority). On the other hand, technical decisions are likely to be poorly understood by the electorate, which is problematic for the democratic process. How many voters get a doctorate in economics to improve their understanding of monetary policy or of local loop unbundling in telecommunications, and to thereby inform their vote? How many voters study for a doctorate in history and geopolitics to improve their ability to assess their government’s policy in the Middle East? How many voters analyze their local public transit system’s productivity, or know the data on the effectiveness of alternative education or housing policies? How many voters make a serious effort to become familiar with the details of scientific subjects such as GMOs, fracking, or global warming? These are all difficult questions even for the experts who have PhDs. The consequence of citizens’ lack of expert information is that technical decisions are vulnerable to regulatory capture by the most powerful (in terms of financial and media resources) or the best organized interest groups.
This is not to blame ordinary citizens any more than politicians. I could not do so with good grace, as I often evaluate political choices with sketchy information as well. I simply want to draw attention to the consequences of this information gap, which we must take into account.
Democracy was conceived as, “the worst form of government except for all those other forms that have been tried from time to time,” in the famous words of Winston Churchill. The modern state that has emerged from the philosophy of the Enlightenment seeks to be independent of special interests. Limiting the influence of elected officials on the career paths of the civil servants who are answerable to them is part of this philosophy. The creation of independent authorities is another instrument that allows democracies to respond to considerations other than short-term polls and to limit pandering to interest groups. The French Republic’s web page10 sums up the advantages of this independence concisely:
The independent administrative authority has sought to meet three needs: providing public opinion with a greater guarantee of the impartiality of state interventions; allowing greater participation by persons of diverse origins and competencies, especially professionals in the sectors supervised; ensuring a rapid state intervention suited to the evolution of needs and markets.
This encapsulates neatly Tocqueville’s admiration for the tradition of administrative independence he observed in the early nineteenth-century United States.11
INDEPENDENT AUTHORITIES ARE NEVER FULLY INDEPENDENT
If decision makers who are not subject to electoral sanction (judges in many countries, or economic regulators) act with greater freedom, the opposite side of the coin is the absence of accountability if they behave badly. To limit the risks of independent agencies drifting away from serving the common good, independent and respected people must be selected to run them, must submit to appointment hearings focused on their qualifications, and if possible should be appointed with bipartisan support. Favors or loyal service to a party or a politician should never be taken into account. Once in place, consultation, transparency, and the requirement that their opinions be based on sound arguments all create incentives to make socially justified decisions; publishing an evaluation of those decisions by experts who are independent of the agency can expose misjudgments.
An “independent” authority must not be (and never is) totally independent: a suitable legislative supermajority must have the power to suspend the leaders of this agency on the basis of their overall conduct (and not on a specific, hot political question). Finally, potential conflicts of interest must be taken into account and dealt with directly and explicitly through procedures that limit their impact.
EXPLAIN, DON’T COMPLAIN …
The prevailing hostility to independent agencies often owes much to the electoral calendar. For example, the anti-ECB rhetoric in Europe is in some ways political posturing that has few direct consequences, since the bank’s independence is written into multilateral international agreements, and no member country has much chance of convincing its European partners to put the ECB under political supervision.12
But the indirect consequences are more serious. For one thing, the bashing of independent agencies may eventually subordinate them to political power. What’s more, populists who attack institutions that were set up expressly to avoid vote-seeking excesses can only increase their fellow citizens’ distrust of public life. To take another European example, the French and Dutch no vote in the 2005 referendum on the proposed treaty establishing a consolidated constitution for Europe showed the impact of several decades of scapegoating and “Brussels bashing.” True political courage would consist of trying to reconcile citizens to modern democracy, in which independent authorities have an important role to play.
REFORMING THE STATE: THE EXAMPLE OF FRANCE
A NEW CONCEPT OF THE STATE
The concept of the state has changed. Formerly conceived in many countries as a provider of jobs through the civil service and a producer of goods and services through public enterprises, in its modern form the state ideally sets the rules and intervenes to correct market failures, rather than substituting itself for the market as a mediocre manager of enterprises.13 When markets are failing, the modern state regulates. It assumes the responsibility for creating equality of opportunity, healthy competition, and a financial system not dependent on bailouts using public money. It finds a way of making economic actors act responsibly with regard to the environment, of establishing equality in health insurance coverage, of ensuring protection for employees who do not have the information that would empower them (safety in the workplace, the right to high-quality training), and so on. In its operations, it is nimble and reactive.
However, this transition requires a return to fundamentals (what is the state good for?) and a change of mindset. Bureaucrats must no longer be “in the service of the state”—an unfortunate expression that completely loses sight of the public interest—but rather “in the service of the citizen.”14 Countries in which the state is still perceived as a provider of employment and a producer of goods and services may need to evolve toward the model of the state as arbitrator.15
The modern state must have the financial means to sustain the social welfare system to which its citizens have become attached. On this subject, France could take inspiration from other countries just as attached to their social systems, but appreciating that its continued existence requires rigorous management of public finance.16 France’s public spending is currently among the highest in the world: government expenditure is more than 57 percent of GDP!17 In 1960, during the trente glorieuses,18 the proportion was 35 percent.
Rising public expenditure is not inevitable: between 1991 and 1997, Sweden decreased its public expenditure by 10 percent of GDP. Thanks to private contracting, the number of government officials fell from 400,000 to 250,000 in the 1990s. Sweden retained only a few hundred officials in its ministries, with a mission to define strategy, compare budget options, and enable debates. The Swedish government delegated operational activities to about one hundred specialized agencies making independent decisions about recruitment and remuneration. It was able to rationalize its services. For example, underused postal services in rural areas were transferred to grocery stores and service stations, producing cost savings but also allowing some of these businesses to survive, thus combatting the flight to cities.
In countries plagued by a bloated public administration,19 required reforms have long been identified: reduce the number of and reallocate public sector employees, substitute open-ended labor contracts for lifelong jobs, eliminate duplicates,20 reduce the number of political layers,21 empower public-sector managers in exchange for a strict ex-post evaluation and interference if these objectives are not met, and so on. Yet reforms frequently fail, despite the best of intentions. A few principles may increase the chances of success.
1. Use benchmarks to convince. Compare with the best international practices and understand the reasons for the difference. How do students perform in comparison to students in other countries? Can income taxes be collected at lower cost? Do hospitals offer the best care possible given the funds at their disposal—or, in an equivalent way, are they spending only as much as they need for the quality of the care provided?
2. Identify the best way to address the problem. The Canadian reform process, when the federal government set its public finances in order by slimming down by 19 percent between 1993 and 1997, is emblematic in this respect. For each program, Canada asked the pertinent questions: Is the program in the public interest? If so, could it be provided by another branch of the public sector or by the private sector? Is the cost affordable and are there alternatives? Straightforward questions like these can lead to creative solutions. Nothing is off limits, but there is a dialogue with the public to adjust and explain the program.
3. Do not cut across the board. Identify what is essential as well as what is not, what works as well as what doesn’t. In Canada, social welfare programs (healthcare, the judicial system, housing, immigration) were not much affected, but subsidies for businesses fell by 60 percent and the budget of the Ministry of Industry and Transportation was cut in half.
4. Monitor the conformity of policies with objectives. Reforms can go awry. For example, the regrouping of structures to eliminate duplicates often has the opposite effect in France. Instead of producing savings, it ends up creating additional jobs and structures to coordinate authorities that remain unchanged. Detailed plans should be presented to an independent authority that would have the power to ask the actors to go back to the drawing board if there are no real savings, and that would provide follow-up monitoring.
Germany, the Netherlands, the Scandinavian countries, and Canada are all countries with social-democratic traditions that have preserved a high level of public services and social welfare protection. They have succeeded in reducing costs while maintaining services. They have also succeeded in making reforms by packaging them together. Isolated reforms are difficult to carry out: single-issue lobbyists focus on stopping them, while the (usually numerous) potential beneficiaries are either not aware of what they would gain, or perceive their potential individual gain to be small, and therefore free ride. A comprehensive reform offers an overall view of a larger pie and assists the losers.
“BUT THIS IS NOT THE RIGHT TIME”
Several general lessons can be learned from efforts around the world to reform the state:
1. Broad reforms are possible.
2. They must be planned for the long haul. Although bipartisan support can prove hard to achieve in some cases (think of US health care reform), in many countries, the opposition party has publicly supported, or at least not attempted to derail, government efforts to sustain reforms in the national interest, such as the fiscal sustainability of the social welfare system. The opposition has continued the reforms when it returned to power, providing a good example of the proper functioning of these democracies. Many reforms of the state have been implemented by the left: by Jean Chrétien in Canada, Gerhard Schröder in Germany, the social democrats (particularly Göran Persson) in Sweden, and Michelle Bachelet in Chile, for example. The reforms were subsequently respected by the right.
3. If they are well explained and made early enough, these reforms are often rewarded by the electorate. Jean Chrétien remained in power for thirteen years and Göran Persson for ten.
4. In France, and elsewhere it is often objected that the time is not right to introduce reforms, as a struggling economy makes it hard to compensate the losers of reforms. And yet the great majority of the reforms mentioned here were made precisely under difficult conditions. The Swedish reforms were adopted in an especially difficult context. After the bursting of the financial bubble and the banking bailout in the early 1990s, and despite a devaluation, Swedish GDP fell by 5 percent between 1991 and 1994, unemployment rose from 1.5 to 8.2 percent, and the budget deficit reached 15 percent in 1994! Finland’s almost simultaneous reforms were decided upon in an equally difficult economic context, against the background of the collapse of the Soviet Union, Finland’s most important commercial partner. Schröder’s Germany was also in a difficult situation; it was having a hard time coping with reunification and was facing demographic prospects catastrophic for welfare programs. In the 1990s, Canada was also in bad shape: the total public debt (the federal government, the provinces, and the municipalities) was approaching 100 percent of the GDP, and repaying it was beginning to make itself painfully felt.
Examples could be multiplied: a difficult economic situation can help, not hinder, reforms.