Why government is a hot topic at Davos

Each year there are just a few hot topics that trend at Davos. It has become something of a sport for journalists and experts to pitch their brand of what counts in the days before the meeting kicks off. My own, slightly delayed, take is that the real topic for Davos this year is the changing role of government as an enabler of economic recovery.

Davos participants are encouraged to see this year as the “year of sustainability”. Foremost in discussion are the United Nations’ new Sustainable Development Goals, the closest the world has ever come to a set of universally-adopted goals. Equally profiled will be the global climate change negotiations, which will reach a critical moment in Paris in December, where binding commitments covering emissions and financing are meant to be agreed.

Yet immediate problems mean that most business and policy makers do not focus on longer-term issues and or even opportunities, especially if there are associated economic and social costs. January has provided more than enough for Davos` participants to digest, for example, with the dramatic rise in the Swiss Franc against a backdrop of collapsing oil prices, the unbalanced growth of European deflation, breakaway growth in the US, and volatile conditions across most emerging markets. Many social and political concerns are equally pressing, with inadequate jobs growth threatening social stability and international security concerns adding to a sense of crisis.

Sustainability`s logic risks being sidelined by these pressing issues, although it is the bedrock of sound, long-term economics. Inclusive prosperity requires that we live within planetary boundaries as well as securing the sense of equity that the recent Oxfam report on wealth inequalities highlights as being lacking. We need ways to bridge the short with the long-term agenda, to overcome the “tragedy of horizons”, a term coined by the Bank of England Governor, Mark Carney.

Markets are not providing an effective bridge to the longer term. Yet if governments have to provide that bridge, there is much dispute as to how. Today`s economic titans offer differing analysis and solutions. Jeffrey Sachs has challenged Paul Krugman`s advocacy of debt-financed public investment, arguing that the case of Japan demonstrates that such an approach might not work, whilst leaving a legacy of public debt to be paid by future generations. Lord Adair Turner, now senior fellow at the Institute of New Economic Thinking, has questioned the benefits of expansionary monetary policy, arguing that a fiscal stimulus would be more powerful and equitable, and ultimately less expensive to the state and its citizens. Lawrence Summers continues to argue that “secular stagnation” rather than cyclical factors underpin our current predicament, just as Thomas Piketty maintains his elegant view of a natural growth in inequality. Both see different roles for government, debt-financed public investment in the case of Summers and a wealth tax as Piketty`s preferred state-dictated fix.

Emerging nations have some compelling experiences to share of robust government intervention in the pursuit of long-term development. Industrial and economic policy planning are back in fashion, not least because of the importance of China`s experience in deploying top down planning to catalyze and direct market actors. Anyone interested in the green economy transition, similarly, is necessarily interested in the role of the state. Emerging nations once again provide important lessons, on how the state can power new industries, force the pace of transition and engage central banks and financial regulators in the pursuit of green financing needs.

State control is not, of course, “the silver bullet” answer to managing asset bubbles, avoiding secular stagnation or mitigating climate change. Needed is a smart state, suitably empowered, informed and capable of taking coherent action, what Mariana Mazzucato calls the “entrepreneurial state”. Developed and developing nations share a comparable agenda, although they may be approaching the problem from two different ends of the spectrum. Developing countries are seeking to liberalize their economies whilst maintaining coherence, stability and and a strategic direction of travel. Many developed countries, on the other hand, have been through an intensive period of liberalisation, and are now questioning whether it has gone too far.

Oversight of the financial system is a case in point. The third progress report of the UNEP Inquiry into the Design of a Sustainable Financial System, “Pathways to Scale”, is released this week at Davos. It focuses on the role of stewards of the financial system in setting rules to advance an alignment of the financial system with sustainable development. The facts are straightforward. Global financial assets of around US$300 trillion are not deployed today in ways that nurture the real assets that create value today and into the future: human, social, natural and physical capital. Today’s US$80 trillion global economy damages the environment annually to the tune of an estimated US$7 trillion. This destructive loss of value is driven by financing that continues to increase in carbon and natural resource intensity. There has been exciting although still modest growth in green bonds, and it is important to acknowledge the sign-up of major stock exchanges, institutional investors and banks to a number of voluntary sustainability principles, codes and reporting commitments. More is needed, however, much more.

More fundamental realignment of the financial system to sustainable development needs the stewards of the financial system to embrace its, and so their, broader purpose. Most OECD countries, for example, see the role of those mandated to oversee the financial system as being to maintain monetary and financial stability, and the integrity and efficiency of financial markets. Broader policy objectives are considered not to be compatible with sound oversight, although there are exceptions such as the US Federal Reserve`s mandate to act in support of high levels of employment.

Central banks and financial regulators in developing countries, on the other hand, whilst sharing these core objectives, start in a different place. Financial markets, in their minds and actions, exist to serve the needs of the real economy and so national development. Oversight of such markets, from this perspective, is an integral part of a broader economic policy framework. Not surprisingly, therefore, it is the financial market rule makers in emerging nations, from Bangladesh to Brazil and China to South Africa, that have proved more open to integrating environment and equity into their frame of reference, and so also their actions.

There are a few, important exceptions, where developed country actors have taken leadership in connecting the dots. Standard & Poors, for example, has led the way in embedding climate risk into credit ratings, and the Bank of England has initiated a prudential review of the systemic risks that climate poses to the UK financial sector. Such forward-thinking is encouraging, and the UNEP Inquiry is seeking  to advance convergence between developing and developed country approaches, channeling insights and approaches through dialogue and active engagement with international institutions and processes, such as the Financial Stability Forum, and the G20.

Government, or more broadly public bodies, alongside business, is key to setting us on the right path, out of the economic turmoil of recent years and towards a sustainable development pathway. Getting government right is the art of a successful economy, and the challenge of developed and developing countries alike. Davos can usefully focus on this topic.

A version of this article is also published in China Daily.

Author: Simon Zadek, Co-Director, Inquiry into the Design of a Sustainable Financial System

Image: A general view of the office buildings and Guomao Bridge (bottom) in Beijing’s Central Business District, August 4, 2010. REUTERS/Jason Lee