The return of big government

Key takeaways

• The role of the state in the regulation of economies has tended to vary over time.
• Since the financial crisis of 2008-2009, the state’s role in regulating the economy has returned to centre stage. Indeed, the rapid succession of crises since 2008 has forced governments to intervene forcefully and repeatedly in order to avoid economic and social breakdown.
• The comeback of the state has myriad economic, social, geopolitical and financial causes.

The return of big government, a key investment theme

The state’s economic footprint has tended to vary over time and according to ideological propensities. On the one hand, economic liberals lean towards shrinking the role of the state to give maximum flexibility to market mechanisms, while on the other hand, classic ‘demand-side’ Keynesians advocate broad state intervention across many dimensions. Throughout history, the pendulum has swung slowly but regularly between liberalism and Keynesianism, between small and big government. Over the last hundred years, the pendulum has swung twice—and might be in the process of doing so again.

The period from the 1920s to the 1960s was the last era of big government, marked by heavy state intervention. In the wake of World War One (1914-1918), inequality, mass unemployment and the impoverishment of growing segments of the population led to calls for government to play a bigger role in the economy. Totalitarianism rose in major European countries, including Germany and Italy, subordinating many aspects of individuals’ lives to the authority of the state.

In the US, the Great Depression of 1929-1933 also resulted in a larger state. Franklin D. Roosevelt’s ‘New Deal’ brought about significant changes in labour law and social security protection and led to the creation of many federal programmes and agencies.

As governments grabbed ever more power during the 1930s, a neoclassical school of thought promoting free-market principles emerged among economists at the University of Chicago.

The economic liberals corpus generally viewed government intervention with suspicion, and instead advocated market mechanisms to achieve economic growth and prosperity, including the transfer of state prerogatives to the private sector. Privatisation, deregulation, free trade and fiscal austerity were typically part of the programmes of the Chicago School and other economists who came to be known as ‘neoliberals’.

The UK and US, under the lead of Margaret Thatcher and Ronal Reagan, put the neo-liberal corpus into practice in the 1980s, with the role of the state greatly reduced in both places.

Since the financial crisis of 2008-2009, the state’s role has returned to centre stage. Indeed, the rapid succession of crises since 2008 has forced governments to intervene forcefully and repeatedly in order to avoid economic and social breakdown.

The return of big government can take many shapes. For example, the administration of Donald Trump was stridently protectionist, yet did not attack the US’s fundamentally liberal economy, whereas state capitalism sits alongside an increasingly regulated private sector in China. The massive investments needed for climate transition and efforts to ‘decarbonise’ national economies are also avenues for state interventionism. Europe, for example, has launched a EUR750 bn package to fight climate change and foster digitalisation.

The comeback of the state has myriad economic, social, geopolitical and financial impacts. For example, growing state interventionism to curb inequalities and to prop up economies in times of crisis has contributed to an explosion in public debt. The debt/GDP ratio of developed countries climbed, on average, from 30% to 120% between 1980 and 2020. There are several reasons to believe the state’s economic footprint will expand further, leading to more public debt. Climate change, ageing populations and stubborn inequalities will be among the main challenges of the next decade likely to prompt sustained government intervention.

Rising state intervention will have significant consequences for investors. Growing public debt has already shaped central bank’s monetary policy over the past decade, keeping interest rate and bond yields at very low levels. And even if we are now at a turning point as many central banks seek to normalise monetary policy, they will probably continue to keep an eye on debt dynamics. The increase in investment spending to fight climate change has also contributed to increase green bond issuance and the attractiveness of that market. State intervention is also having an impact on equities. For example, new, tighter regulations in China on a number of industries from for-profit schooling to real estate and internet platforms had a significant impact on markets by increasing volatility. In the west, defence buying in response to the Ukrainian war and tighter regulation social media are further examples. In all, markets will not be immune from increased government activism, which will probably remain an important investment theme for the next decade.