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Return of big government raises political risk

SINGAPORE (Reuters) - Big government is back.

Governments battling to stop the global financial crisis toppling banks and choking the world economy have found themselves, whether they like it or not, nationalizing vast chunks of the corporate landscape and intervening heavily in areas long seen as best left to the free market.

Politicians are suddenly central to the future of the global economy. And so political risk -- specifically the impact of government policies on asset prices -- has rarely been higher.

“First, we’ll see more state intervention in the global economy. Second, that intervention will be both reactive and uncoordinated by a series of local, regional, and national political actors,” said Ian Bremmer, president of the Eurasia Group, a leading risk consultancy, in his outlook for 2009.

“Politics will drive the global economy more directly, and more inefficiently ... than at any point since World War Two.”

For years, political risk has been seen as an important issue only in emerging markets, where markets are often at the mercy of capricious or uncertain government policies. In most developed economies, political decisions rarely had a major market impact.

All that has changed. Even the United States, the soul of capitalism, has had to effectively nationalize much of its banking and auto industries. It will be U.S. legislators, not free markets, who play the decisive role in the economy in 2009.

“The most far-reaching reactions to the global financial crisis -- the biggest stimulus packages and the policy decisions with the most important economic implications -- will come from the United States government,” Bremmer said. He sees the U.S. Congress as the top source of global political risk in 2009.

“Decisions ... are driven by domestic political interests,” Bremmer told Reuters. “The same is true in Beijing, Moscow, New Delhi, Brussels, Tokyo, and everywhere else that politicians are taking on new responsibilities for ... economic performance.”

PROBLEMS

The belief that free markets in general order the world far more efficiently than government interference has taken a severe knock from the financial crisis. To many, both inside and outside politics, this is a clear argument for more state intervention.

Yet several analysts warn that governments may only end up making things even worse. Market solutions may have failed, they argue, but this does not mean governments will do any better.

One key reason is that governments will often be following a national agenda, but the crisis is global.

“The financial crisis has underscored the need for policy responses that account for the global nature of crises,” said the World Economic Forum’s 2009 Global Risks report last week.

“It has revealed the limits of the current financial architecture, shown the inadequacy of early warning systems, and exposed deficiencies in the coordination among policymakers, regulators and supervisors.”

Secondly, even well-intentioned interventions that look beyond narrow national interest may have unintended consequences due to the complexity and interconnectedness of the modern world.

“The financial crisis makes it impossible to ignore how interconnected and interdependent the global economy has become in the last two decades,” security consultancy Control Risks said in its 2009 outlook. The WEF’s annual Global Risk reports include an explicit attempt to map the connections between risks, to show that problems cannot be tackled in isolation.

Thirdly, governments often have a tendency to over-regulate in a crisis, and regulations are usually designed to prevent the crisis that has already happened, not the unknown crisis to come.

“Regulation rushed out during a crisis often has unwanted perverse effects and sometimes even fails to achieve its stated objectives,” said Nomura analyst Alastair Newton.

And finally, by disrupting the market system of incentives, government intervention can create all kinds of havoc.

“Intervention in support of the financial and manufacturing sectors carry the risk of rewarding failure or propping up inefficient corporations and industries,” the WEF report said.

“There is also an inherent risk of creating uneven playing fields for companies excluded from access to government funds.”

SOLUTIONS

The most obvious way to improve global coordination, prevent beggar-thy-neighbor policies and ensure complexity is taken into account is to bolster global institutions -- or build new ones.

“There can be little doubt that global governance and institutions ... need to be strengthened,” the WEF report said.

But, it added, “this is easier said than done.”

The G20 group of countries rather than the narrower G7 which excludes key emerging economic powerhouses has become the key policy coordinating forum. But its last summit on tackling the crisis, in November, promised much but delivered little.

Nomura’s Newton said that the emergence of the G20 was nevertheless encouraging. “To date, the signs are that this shift to the larger forum has been broadly accepted, although the acid test, in our view, will likely be on April 2, 2009, when the next G20 meeting will be hosted.”

But even if the G20 gains traction, it remains more of a forum for discussion than a body that can decisively coordinate crisis response. So the pitfalls of government intervention remain -- and political risk will be paramount.

In the end, the WEF report said, the best that can be hoped may simply be that government intervention is well-flagged and transparent, to help markets understand the risks.

“From the corporate perspective, the current uncertainty about the extent of the changes that may happen in 2009 is difficult to manage,” it said.

“The changes need to be measured but to reduce uncertainty they must be communicated swiftly to allow business to track them across their markets and take the necessary actions.”

Editing by Bill Tarrant

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