Adam Smith Institute

Google Alerts tell me that I've been quoted around the world for saying, of the current markets crisis: 'This time next year we'll be seeing things back to normal.' Each one comes as a surprise, because I don't remember saying that. But it's true.

We've grown up for so long being focused on America as the world's engine of growth that any problem there looks like a catastrophe. 'When America sneezes, the world catches cold,' as they say. That might, of course, be true of bankrupt little Britain, which I figure is already in recession. But much of the rest of the world isn't even sniffling. In fact it is in rude health. I'd wager that 2009 won't see the world plummeting into disaster, and that world economic growth will come in at 3% – or more – well above what our little corner of it has been able to achieve in the last decade or three.

There's been so much dust flying around Wall Street that people seem blind to the fact that China, the world's fourth-biggest economy, is still growing 8%-10% a year, and retail sales there are up 16% real on last year. China's shoppers are now more important to world prosperity than America's. And (like the Brits) Americans have financed their shopping spree by borrowing, which they're going to be doing less of now that falling house prices make them feel poorer. We're seeing a global shift in the economic realities.

Of course, it's not over for America, or even Britain. As their currencies slide they are exporting more – precisely to those places, like China and India, which are growing fast and need their specialist skills and equipment to make that expansion happen. The financial markets of America, Britain and to a lesser extent Germany might be jumping out of windows, but the real economy is out on the street, selling. As Adam Smith said, there's a deal of ruin in a nation. There's a deal more in a world.

Everyone seems to be agreed: the bail-outs to financial firms mean we will all have to pay more tax, or our governments will have to borrow more (leaving our children to pay more tax). But why should this be? Once the financial sector picks itself up, the debt that Hank Paulson wants to buy may turn out to be less toxic that everyone supposes. And Uncle Sam will have bought it at a nice knock-down price, thanks to the fact that he's the only one out there with any cash to buy anything at all.

But even if I'm wrong, why does everyone assume that taxation or borrowing are the only ways to pay for increased spending? What happened to the idea of improving the efficiency of how governments spend money and run services? The debate was an active one in the UK four or five or six years ago. After a couple of years restraint, the Blair-Brown government started throwing money at education, health, and other spending programmes. They proved themselves so inept at handling it that Sir Peter Gershon (pictured left) was brought in to explore how the civil service could be made more efficient. He found billions of pounds worth of gains. But now the debate has flagged. It needs to be revived.

The first thing we need to do is tackle public-sector pensions. It's not just that they are a costly liability for the future. It's that they make civil servants much more difficult to remove, since that liability gets crystallized when you make a civil servant redundant. That makes it much, much more costly for the government to downsize than for private firms to.

And maybe some projects should simply be abandoned. When ID cards or the NHS IT system were mooted, nobody had the faintest idea what they would cost. They just lumber on, getting more and more costly. It's time for a hard look at these and other spending programmes. On the other hand, we should be spending more money on efficient managers who can lead government's huge projects. They need the best project leaders in the world, not just the civil servants who happen to have seniority. Most of them, like their ministers, have never actually run anything in their lives.

The rule should be that all government activities should be contestable. Government should be in the commissioning business, not the provision business. Getting other people to do the provision, bringing in new ideas and facing competitive pressure from others, would save taxpayers billions. Easily enough to buy the odd bank or two.

As a good free marketeer, I love failure. It's something inevitable in the market economy, where there's no job for life. From time to time, businesses are overwhelmed by the competition, or simply make mistakes, and they fail. But new ones come along, so nobody gets too agitated about it.

Unless of course, they are big. Then the politicians step in, concerned about the political effect of job losses. When they are big financial institutions, the politicians are even more agitated, in case they also bring down other businesses that depended on them for finance. That's why the UK government nationalized Northern Rock and the US bailed out Fannie and Freddie.

The UK and US authorities have also been encouraging mergers to save big financial institutions, like HBOS and Lloyds TSB last week. But in so doing they create even bigger financial institutions, which ups the stakes even more when things go wrong again.

The regulators are on an impossible spiral. Regulation has grown more and more onerous, forcing financial firms to merge in order to absorb the cost. That created larger institutions, which couldn't be allowed to fail. And it reduced competition, making them less nifty and actually more likely to sink when they hit troubled water.

Now the regulators are going round the spiral again, creating yet larger institutions. You have to ask, though, whether even governments will have enough cash to keep these monsters afloat when the waters next get choppy.