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Valuation Models for Government January 22, 2007

Posted by federalist in Government.

What makes a good government?  Andy Grove in today’s WSJ has an interesting article suggesting that society does a terrible job strategically managing its governments, and he starts with a good analogy:

If business’s task is to generate revenue and profits for its owners, what is the equivalent task for a nation and its government?

It is an apt analogy: A nation has shareholders (generally all are minority shareholders, but there are to this day degenerate cases like North Korea where there is a majority holder) who elect trustees (e.g., the judiciary) and a CEO (e.g., the President).  And the CEO can have an enormous impact on whether the government achieves its objectives.

What are government’s objectives?  This is a normative question: Communists may say that it is to maximize human equality.  Islamists may say it is to spread Islam and destroy all unbelievers.  I like Grove’s suggestion that just as the measure of a company’s value is its risk-adjusted earnings stream, so the measure of a nation’s value is its risk-adjusted GDP.  I believe a country that maximizes that number will maximize the net welfare of its citizen shareholders.

It would be a big step forward to agree that this is the purpose of government, and to explicitly evaluate government in these terms.  Fortunately, the markets provide many instruments for estimating the risk-adjusted GDP of a country.

What we are left with is the same problem shareholders face when evaluating a CEO: There are many exogenous factors — completely outside of the CEO’s control — that affect a company’s profitability.  Incompetent CEOs can get lucky, and brilliant ones can still suffer calamity.  Likewise, a country may be resource-rich, or it may be prone to natural disasters of various sorts.  Just as with CEOs, we may never be able to make a literal A-B comparison.  But we can discern the characteristics of good government just like we can show the principles of good corporate management.  And we should seek governments that enhance risk-adjusted GDP.

(Note that, just as corporate governance is frequently undemocratic, it is possible that the best national governments by these standards are not necessarily purely democratic.  Fareed Zakaria, in an otherwise rabid article, makes the valuable observation, “The basic problem confronting the developing world today is not an absence of democracy but an absence of governance.”)



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