Why we need a new compact between business and government

The Nobel laureate economist Paul Krugman once quipped that “Canada is essentially closer to the United States than it is to itself.” After all, most of its citizens live in a narrow band along the more than 3,000-mile-long border. Most Canadians live closer to more Americans than they do to other Canadians.

The same can be said of corporations and governments. Most firms are closer to the government than they are to other firms: they interact with government rules and agencies more than they do with the rest of the business community. The quality of that interaction and its evolution over time is probably the most fundamental determinant of a country’s potential for growth and prosperity.

But this is not the Weltanschauung – the worldview – that permeates private-sector discourse, especially the views expressed by most chambers of trade and industry and business associations around the world. Business organizations often hew to Ronald Reagan’s dictum: “Government is not the solution to our problems; government is the problem.”

It is a great sound bite: short, recursive, and somewhat poetic. Unfortunately, it is also dangerously misleading. After all, even if government were the problem, then changing what it does must be part of the solution.

The truth is that markets cannot exist without governments, and vice versa. Governments are essential to the establishment of security, justice, property rights, and contract enforcement, all of which are essential to a market economy.

Governments must also organize the provision of infrastructure for transportation, communication, energy, water, and waste disposal. They run and regulate health-care systems and primary, secondary, tertiary, and vocational education. They create the rules and provide the certifications that allow firms to assure their customers, workers, and neighbors that what they do is safe. They protect creditors and minority shareholders from miscreant managers (and managers from impulsive creditors).

Saying that governments should get out of the way and let the private sector do its thing is like saying that air traffic controllers should get out of the way and let pilots do their thing. In fact, governments and the private sector need each other, and they need to find better ways to collaborate.

The problem is that in many countries, both developed and developing, the current relationship between the private sector and the government is often dysfunctional. Not only is it characterized by deep distrust, but the broader society does not find a closer relationship to be either legitimate or in the public interest, and for good reason.

The private sector often engages with the government in order to make itself more profitable. After all, maximizing profits is what CEOs are supposed to do. And the government has ways to help: It can force suppliers to sell their inputs more cheaply, repress workers’ wage demands, protect the final market from competition by imports or new entrants, or lower their taxes.

But these schemes make firms more profitable by making their suppliers, workers, and customers poorer. Accepting such demands makes the government rightly illegitimate in the eyes of the rest of society, which cherishes higher priorities than redistribution in favour of the already rich.

Outcomes would be very different if the focus of the relationship were productivity rather than profitability. Productivity improvements, by lowering costs, allow firms to pay their workers and suppliers better, reduce prices for consumers, pay more in taxes, and still make more money for their shareholders. A focus on productivity is win-win-win.

Governments can do many things, in a variety of areas, to raise productivity. Fresh produce requires a cold-storage logistic system, a green lane at customs, certification of good agricultural practices, and sanitary permits. Tourism depends on sensible visa requirements, convenient airports, road signs, hotel construction permits, and the preservation of cultural sites and coastlines. Manufacturing requires dedicated urban space that is adequately connected to power, water, transport, logistics, security, and a diverse labour force.

All of these productivity-boosting inputs require institutions that teach and extend industry-relevant knowledge and skills. None of them appears in the World Bank’s Doing Business indicators or the World Economic Forum’s Global Competitiveness Index. And yet, without these public inputs, the industries that depend on them cannot succeed.

That is precisely what happens in the absence of a sound and legitimate basis for cooperation between the government and the private sector. The result is inadequate provision of public goods that raise productivity and make everyone better off.

To create such a basis for cooperation, many countries need a new compact between the government and the private sector. This will not be possible if business groups insist on putting taxes at the center of the discussion. Instead, they should focus on measures that raise productivity.

More broadly, business groups should seek only those government policies that are unambiguously in the public interest. Demands that are perceived as greedy erode legitimacy and, ultimately, effectiveness. In this context, watchdog NGOs dedicated to scoring the public-interest value of what business groups ask for from the government could facilitate trust.

Perhaps most important, business associations do their members a disservice by seeking to impose on them a single voice. Doing so usually leads to a focus on policies that are preferred by all members – such as lower taxes – instead of measures that are important to the productivity of each member. Just as monopolies are bad for markets and politics, business representation in the private sector would benefit from more competition.

This article is published in collaboration with Project Syndicate. Publication does not imply endorsement of views by the World Economic Forum.

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Author: Ricardo Hausmann is a former minister of planning of Venezuela and former Chief Economist of the Inter-American Development Bank, is Professor of the Practice of Economic Development at Harvard University.

Image: A man walks past buildings at the central business district of Singapore February 14, 2007. Singapore’s trade-reliant economy expanded faster than expected in the fourth quarter on a pick up in domestic activity, data showed on Wednesday, prompting the government to lift its expectations for 2007. REUTERS/Nicky Loh.