In particular, the fact that over the past three decades people have become increasingly aware of the growth-enhancing effects of product and labor market liberalization, has led number of scholars and policy makers to also recommend a reduction in the role and size of governments. True, the recent crisis showed the importance of the state as a regulator, however current opinion swings in the US and other industrialized economies show that doubts remain as to whether governments should go beyond maintaining law and order and regulating financial systems. At the same time, there is the striking example of Scandinavian countries, where governments remain big and yet markets have been liberalized and the rates of innovation and productivity growth have increased over the past two decades. In this paper we argue that it is not so much the size of the State which is at stake, but rather its main functions. It is not so much a reduced state that we need to foster economic growth in our countries, but of a “suitable” state. More specifically, in this paper we shall point to two main growth-enhancing functions of governments in addition to regulating financial systems. The first as an investor in the knowledge economy. The second is as a guarantor of the social contract.
