The Global Economy and the New Role of Governments

by Roy L. Simerly

Roy L. Simerly is a professor in the Department of Management, East Carolina University. 

If you would prefer a different background color, you, select it by highlighting the color you prefer in the scroll box below

There is a considerable degree of concern these days over the possibility that there will soon be a ‘world governing body.’ Well, the good news is, a significant portion of that body already exists in the form of the World Trade Organization and the World Court, and it won’t be long before the process is complete. The bad news is that very few people understand the forces at work creating this body, and fewer still understand just why we need "it," whatever form it may take. The short answer is that since the nation-states have lost their original purpose, and their ability to govern, there is need for a new form of supra-ordinate governing body to administer the affairs of the governed. The only alternative would be to leave control in the hands of economic entities such as OPEC to make decisions. Scary, but true.

A Brief History Lesson  

To better understand why there is a necessity for a supra-ordinate governing body we need to take a very brief look at history. Specifically: the economic system known as mercantilism provided the basis for the role of government that has dominated the history of the nation-state. With the demise of mercantilism in the 1970s forces were unleashed that lead to the creation of what we now call the global economy. These forces also removed the primary reason for the existence of nation-states, and removed their ability to govern. Thus, we have a power vacuum that is always dangerous. Fortunately, there are many nations and individuals at work filling in the vacuum with elements of a world governing body to replace the outmoded nation-state. While the nation-states will, of course, remain in some form, their primary role has changed. I now consider each of these key elements in turn.


Since the creation of nations, their primary role has been to control the factors of production. In fact, the wealth of nations was determined by the amount of each factor that could be commanded. It was only during the Reformation that control of the factors was allowed to pass from governments and churches to individuals. The primary reason for the colonization of the world by European nations was to expand control over these forms of wealth.  However, governments retained ultimate control by imposing restriction on trade and by other devises meant to protect the inflow and outflow of these factors.  

One of the unanticipated results of allowing individuals to control the factors of production was the amazing success that they enjoyed over the ensuing 3 centuries. Individuals were so successful, in fact, that by the 1950s international trade had expanded beyond the ability of governments to control enough wealth to pay for the transactions. This lead to a very difficult choice. Governments could maintain restrictions on trade to control wealth – and watch that wealth evaporate. Or, governments could make painful adjustments to expand trade – and watch individuals prosper at the expense of national sovereignty. The latter choice was made less painful by the fact that governments could still collect revenue by taxing the profits.  

Fortunately, most of the governments of the developed world make the right choice. In the early 1970s President Nixon took the U.S. off the gold standard. This act was the final death-knell of mercantilism. More propitiously, for the first time in history all of the factors of production were mobile – land, labor, capital and entrepreneurship (knowledge) could cross borders with varying and increasing degrees of freedom.  

This was also the first time in history that money was without intrinsic value. Paper money was no longer backed by gold or silver, or the promise of any government to protect the wealth of holders of currency. Today, the value of money is determined by the faith and perception of millions of individuals, rather than by the dictates of governments.

Global Economy

  In its narrowest sense, there has always been a global economy. That is, people have always traded with their neighbors as a means of creating wealth and satisfying varying needs. However, they have done it through most of history under the aegis of a governing body of some type, be it city-state or nation-state.  

What distinguishes trade today from any other point in history is the degree of interdependence among nations. This interdependence is a product of basic economic principles – to be discussed later – and by the volume of trade resulting from the enormous opportunities created by freeing the factors of product to move where they could be used most efficiently.  While the byproduct of interdependence is greater prosperity, this is a double-edged sword. Whereas it was at least historically theoretically possible to insulate oneself from the problems of other countries, and to ride out any economic storm, today that is not possible.When one nation suffers, we all suffer. Consider the recent earthquakes in Taiwan from an economic standpoint (not humanitarian). A hundred years ago no one would have cared on this side of the Pacific. Today we pay very dearly for our computers because Taiwan was a major provider of computer memory chips. Also, the ‘Asian flu’ of 1998 has created a massive trade deficit in the U.S. today because of the relative devaluation of Asian currencies.  

The point is that the economic prosperity of one country is tied to the economic prosperity of all other countries. Yes, all other countries. That one can point to countries that have not benefited from the economic boom of the past decade is to point rather to governments of countries that have opted out of the global economic expansion and have chosen to allow their people to suffer. We all lose because we have lost the opportunity to benefit from expanding economic opportunities in those countries.  

Another feature of the global economy is the change in the relative value of the factors of production. In 1900 the most valuable factor was capital – or money, measured in gold or silver. The major companies and industries of that day measured their value by the size of their investments in plant and equipment. Today that has all changed. Money, land and labor are, relatively speaking, almost valueless. It is a very simple economic principle of supply and demand. These factors are in great supply, and their demand is lower, and this is reflected in their value. The single most valuable factor today is knowledge. Think of Microsoft! Each day their most valuable assets go home for dinner!  

The changes over the past thirty-odd years has been so dramatic that we now hear phrases such as new economic order, or new world order.  Some have even suggested that it is the end of political history and the beginning of economic history.  Without question, the economy of today is different from anything in history. One would think that if there is a new economic order, there should be new economic principles to guide us. Not so!  Actually, the principles that apply today are those envisioned by David Hume and Adam Smith, among others. The only thing that is really different is that we now have a chance to see them being applied on a global scale. The most important economic principles today are:

1. Individuals will attempt to maximize the utility of any given act;

2. The factors of production must be used efficiently.

Role of Governments Today

The late 1980s saw the demise of both the communist and socialist economic systems. This is important because it proved the principles of Hume and Smith that individuals can and will make better economic choices than will governments. Given that individuals now have more choices available – and that those choices are now on a global scale, the possibilities for maximizing utility are unprecedented. It is not really conceivable that individuals will return to any system that removes personal control over their destiny. More importantly, since the most important factor is now knowledge, no governmental system can be erected to control the use and development of human knowledge. Encourage, yes – control, no.

I agree with Kenichi Ohmae’s observation that the nation-state has become a dysfunctional unit in terms of which to organize economic activity. Smith’s invisible hand of the market has expanded beyond the capability of any nation to control. Today, governments are more focused on protecting the interests of special groups than on expanding economic activity to better the lives of all into the future. Nor can we expect much else because of the nature of the democratic process. However, since the first basic rule of economics mentioned above is true, individuals can easily move their resources out of those countries with less than ideal economic conditions and into those areas where they can maximize their utility.

If governments are no longer able to control the factors of production, what then is their new role?  Actually, it is the same role outlined by Adam Smith. According to his system of natural liberty, governments have only three responsibilities:  

1. To protect members of society from oppression or injustice of each other;
2. To protect society from invasion by other nations;
3. To erect and maintain an infrastructure that supports the public good.
While these responsibilities were presented as theory, Max Weber, over a century later, demonstrated empirically their validity in his study of the preconditions for capitalism to prosper.

The first of Smith’s responsibilities goes without need of much comment. For individuals to maximize utility requires a legal system that can protect private ownership of property, and adjudicate disputes among contracting parties. Only in this way will individuals feel safe in committing their time and talents to enterprises.

The second responsibility is the more difficult today, and is paradoxically the main reason that nation-states must cede sovereignty to a supra-ordinate governing body.  Because the most valuable factor is now knowledge, and knowledge can not be controlled, there is no longer a threat of war as we have known it. There will not be a third world war. Because there is nothing tangible to capture.

However, there is still a threat of ‘invasion’ from other forces almost as destructive as armies – economic entities. There are three of importance: cartels such as OPEC; speculators such as those that made a run on Indonesia’s and Hong Kong’s currencies; and multinational corporations who can use arbitrage to shift business functions from location to location. Since all three of these can adversely impact a nation’s economy, and therefore the state of well being of its people, these represent forces that we need to be protected against. But nation-states do not have the power to provide this protection by definition. Nation-states are geopolitical entities that have a specific degree of sovereignty which they protect. Economic entities operate within the protective embrace of these sovereign nations.

Put another way, far less spectacularly, nation-states which support or condone the activities noted above are acting in an economically inefficient way. If economic history is any predictor, they will soon lose this power – because the factors of production must be used as efficiently as possible.

The third role of government is now the defining statement of the day-to-day function of any government. In a phrase, the role of nation-state governments today is to establish the infrastructure that will attract the factors of production. Only by doing so will their economy receive the investments that are central to economic development. Consider the amount of effort being expended by nations to improve education, build transportation systems, and to expand communication links. There is a direct correlation between these activities and the value of a nation’s currency, and the growth of a nation’s economy.


History tells us that the Athenians predicted the end of the world when the city-state political system was coming to a close. However, in hindsight, we can see the dramatic improvements over the centuries. The next step is now here, with the same dire predictions.  Those who concerned with such issues as the environment or worker rights should embrace this prospect openly. Only a supra-ordinate system could over rule nations such as the U.S. which refused to cooperate on the international effort to reduce green house gasses. Only a supra-ordinate system could eliminate the arbitrage system which allows firms to move product from country to country to take advantage of economic conditions. A supra-ordinate governmental system is needed to replace the economic inefficiencies of the present nation-state system. 

Those entities which have for so long controlled economic growth can now only impede or facilitate.

mbar.jpg (9380 bytes)