Rooting politics in the nation-state is key to resolve global risks – institutionalized governance is the only way to produce stability

Robust nation-states are actually beneficial to the world economy. The multiplicity of nation-states adds rather than subtracts value.

A principled defence of the nation-state would start from the proposition that markets require rules. Markets are not self-creating, self-regulating, self-stabilising or self-legitimising, so they depend on non-market institutions. Anything beyond a simple exchange between neighbours requires investments in transportation, communications and logistics; enforcement of contracts, provision of information, and prevention of cheating; a stable and reliable medium of exchange; arrangements to bring distributional outcomes into conformity with social norms; and so on. Behind every functioning, sustainable market stands a wide range of institutions providing critical functions of regulation, redistribution, monetary and fiscal stability, and conflict management. These institutional functions have so far been provided largely by the nation-state.

Throughout the postwar period, not only did this not impede the development of global markets, it facilitated it in many ways. The guiding philosophy behind the Bretton Woods regime, which governed the world economy until the 1970s, was that nations – not only the advanced nations but also the newly independent ones – needed the policy space within which they could manage their economies and protect their social contracts. Capital controls, restricting the free flow of finance between countries, were viewed as an inherent element of the global financial system. Trade liberalisation remained limited to manufactured goods and to industrialised nations; when imports of textiles and clothing from low-cost countries threatened domestic social bargains by causing job losses in affected industries and regions, these, too, were carved out as special regimes.

Yet the postwar years saw historic growth in trade and investment, in no small part because Bretton Woods encouraged healthy domestic policy environments. Economic globalisation relied on the rules maintained by the major trading and financial centres. National monetary systems, central banks and financial regulatory practices served as cornerstones of financial globalisation. Domestic political bargains, more than GATT rules, sustained the openness that came to prevail. Prosperous communities within nation-states – major urban centres, suburbs and technology hubs – thrived precisely because they could rely on the institutional infrastructure established by national governments.

A truly global economy, in which economic activity is unmoored from its national base, would necessitate transnational rule-making institutions that match the global scale and scope of markets. But there are no such institutions.

Nor are market-supporting rules universal. The United States, Japan, individual European nations and all advanced societies are to varying degrees market societies, but all have also developed historically under different circumstances and institutional setups. These market societies feature divergent practices in labour markets, corporate governance, social welfare systems, and regulation. They all have generated comparable amounts of wealth under very different rules. There is no single institutional recipe for economic success. Yes, markets, incentives, property rights, stability and predictability are important. But they do not imply unique blueprints.

The institutions facilitating capitalism are malleable. History and contemporary reality make this clear. As the political theorist Roberto Mangabeira Unger has emphasised, there is no reason to think that the range of institutional divergence we observe in the world today exhausts all feasible possibilities. Desired institutional functions – aligning private incentives with social optimality, establishing macroeconomic stability, achieving social justice – can be generated in many different ways. The only limit is set by our imagination. There simply is no single best-practice set of institutions.

Institutional diversity among nations is as close as we can expect to a real-life laboratory for capitalism

Given the non-uniqueness of practices and institutions enabling capitalism, it’s not surprising that nation-states also resolve key social trade-offs differently. The world does not agree on how to balance equality against opportunity, economic security against innovation, health and environmental risks against technological innovation, stability against dynamism, economic outcomes against social and cultural values, and many other consequences of institutional choice. Developing nations have different institutional requirements than rich nations. There are, in short, strong arguments against global institutional harmonisation.

Consider the question of how to regulate financial markets. Should commercial banking be separated from investment banking? Should there be a limit on the size of banks? Should there be deposit insurance and, if so, what should it cover? Should banks be allowed to trade on their own account? How much information should they reveal about their trades? Should executives’ compensation be set by directors, with no regulatory controls? What should the capital and liquidity requirements be? And so on.

A central trade-off here is between financial innovation and financial stability. A light approach to regulation will maximise the scope for financial innovation (the development of new financial products), while also increasing the likelihood of financial crises and crashes. Strong regulation will reduce the incidence and costs of crises, but raise the cost of finance while excluding many from its benefits. There is no global answer, no universal formula to apply to these questions. Different communities will find a range of answers to the optimal innovation-stability trade-off. A global solution might have the virtue of reducing transaction costs in finance, but it would incur significant other costs from being out of sync with local realities and preferences. At the moment, financial regulation faces this very conundrum: banks are pushing for common global rules, and domestic legislatures and policymakers are resisting.

Finally, since there is no fixed, ideal shape for institutions, and diversity is the rule rather than the exception, a divided global polity presents an additional advantage. It enables experimentation, competition among institutional forms, and learning from others. To be sure, trial and error can be costly when it comes to society’s rules. Still, institutional diversity among nations is as close as we can expect to a laboratory for capitalism in real life.