The global financial crisis is a turning point for the whole world. Across our economy, society and politics it has unleashed a new impulse for change. When even that most market-orientated President of modern times, George W Bush, backed state intervention to bring order to financial markets, the vestiges of the old Reagan/Thatcher orthodoxy finally crumbled. Governments, whether right or left, are dusting down powers that for decades they have felt unable to use. We are seeing a major change in the assumptions guiding public policy. For decades it was that the state had little role in the market. Now the state is back. Regulation is in.

People who are losing their homes and their jobs are struggling to understand how banks and financial institutions got it so wrong. They are angry and looking to politicians for action. Progressive politics needs to learn the lessons of that era of excess and to acknowledge what went wrong. The trick is to do so without heralding a new era of economic protectionism and state interventionism. Such an approach might be tempting in the present but it is not the answer for the future.

First, because those licking their lips at the prospect of an end to market capitalism – as distinct from the death of unfettered financial markets – risk gorging prematurely on a beast that has life still in it. Markets need to be appropriately managed and properly regulated. And when they are, they work. They unleash innovation and realise potential. They have brought people in countries like our own unprecedented prosperity and opportunity. And globalisation – the worldwide meshing together of markets – has given millions in the poorest countries a route out of poverty in a way that nothing else has ever come close to matching.

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The issue is how to get economic recovery under way and then to refashion our economy so that markets work in the interests of the majority not just the minority. That means increasing transparency and decreasing excess. It means changing corporate governance rules as well as regulatory regimes.

It means encouraging active shareholding and extending employee share ownership. In other words, it means bringing a dose of democracy into the operation of our economy. The job of progressives is not to kill capitalism but to civilise it – by making it work in the public interest.

Second, those expressing glee that financial turmoil exposes the limits of free markets need to remember there are equally limits to the role of centralised states. Of course, only state action – including by the UK Government – could have stabilised our financial institutions and stimulated our economies. Indeed without states agreeing to pool their actions global problems, whether economic or environmental, stand little chance of being solved.

Similarly, when it comes to social change it is inconceivable that disadvantage can be overcome without the state or politics playing its part. Poor people are hardly able to spend their way out of poverty. If Britain is to become truly socially mobile they need help with education, housing, training, childcare and employment. That is why those on the new right of politics who continue to reject the role of the state represent an ideological blast from the past, not a progressive politics of the future.

So the challenges of the modern world call for the state to play its part. They also call, however, for the state to know its place. Government intervention to stabilise and stimulate the global economy must not become the foundation for a wider creeping programme of nationalisation in which the state assumes responsibilities that properly belong either to markets or to citizens.

It is only the state that can equalise opportunities throughout life and empower its citizens. Equally, only citizens can seize those opportunities and realise their own aspirations to progress. So just as the right is wrong to reject the state's role, the left must avoid the trap of countering an argument about less state by making a case for more state. This is not as some claim a moment for leftist politics. It is a moment for a new form of progressive politics.

Meeting the challenges of the modern world calls for a different sort of state: one that empowers, not controls. Faced with the new challenges of global warming and global terror, of mass migration and community insecurity the old top down approach to governance will no longer work.

It is not just that the public have reached the limits of what they will pay in taxes, although they have. Nor is it just that in the next decade fiscal pressures will compel governments – whether of right or left – to be far clearer with their electorates which areas of state spending need to rise and which areas need to fall. But it is also that, just as the global credit crunch and its consequences have exposed the limits of untrammelled free markets, so the new problems politics must confront – how to improve health, beat crime, regenerate communities, safeguard the environment – simply cannot happen if we have to choose between either having an active state or having active citizens. It is not either/or that is needed. It is both.

What made for progress in the past will not secure progress in the future. One example. When New Labour came to power in 1997 the most pressing health challenge was to cut what were then the appallingly long waits that patients had for treatment. A decade on and that old NHS bugbear – long waiting times – has more or less been beaten through a mix of extra resources and top-down reforms.

The challenge today is different and altogether more complex: how to absorb a demand for services that is simultaneously both rising and changing against a dwindling supply of resources. The NHS not only needs to cope with the pressures of an ageing society and advancing technology. It now has to focus on how to improve health, for example by beating obesity and tackling alcohol abuse. It now has to work out how to help the growing numbers with a chronic condition to manage their diabetes or their arthritis. It now has to find ways not just of providing collective care but of shifting individual behaviour.

The problem today is different and so must be the solution. We can no longer treat patients as passive recipients of care in a system that denies them both power and responsibility. Instead they need to be more in charge and more responsible for their own health. Interestingly evaluations from both the US and the UK show that policies which give patients greater control over their own health-care decisions – including their own state-financed health budgets – manage to combine higher levels of personal satisfaction with lower levels of public spending than traditional forms of service delivery.

The challenges of the future call for a different relationship between the state and the citizen than we have had in the past. It is doing things with people rather than to them that holds the key to unlocking progress. That involves governments finding new ways to engage with citizens and communities. Changing behaviour to improve health or tackle climate change will involve governments securing the participation of citizens instead of preaching at them.

It will mean using incentives – including in the tax system – not just passing laws. It is striking that the new generation of political leaders – whether Obama in America or Rudd in Australia – are advocating change based not just on new policies but on a new politics: one that is open, engaging and that favours dialogue over monologue.

Such a change is in keeping with the times. In a world of rampant insecurity and constant change people are looking for greater control in their lives. The problem is that ours remains a "them and us" political system. It was framed in an era of elitism. Rulers ruled – and the ruled were grateful. Economic advance and universal education have swept aside both deference and ignorance. Now the internet redistributes knowledge and offers us the chance of being active participants rather than passive by-standers. Representative democracy worked for the last century. It is a more participatory democracy that will work in this.

Equity demands that it should be so. The sense of hopelessness that clouds the poorest communities grows out of disempowerment. Of course beating crime, creating jobs, rebuilding estates can help. But this cloud of despondency can only be dispelled by allowing both local communities and individual citizens to more evenly and directly share in power. By cutting taxes for the low-paid. By making local services directly accountable to the local community. By making community courts and restorative justice the twin pincers that deter and prevent anti-social behaviour.

By allowing community-owned mutual organisations to take over the running of local services like children's centres, estates and parks. By giving parents new powers to choose schools and patients to choose treatments. And by empowering people in old age, those with a long-term condition, families with disabled children or people in training the right to choose their own publicly-funded budgets instead of conventionally provided services. In other words, by changing the balance between the citizen and the state.

This should be the new agenda for New Labour. Empowering citizens and communities to take far greater control over their lives has always been at the heart of progressive values. Just as at other points in our history an old orthodoxy has been swept away by a new, so this is an idea whose time has come. In 1945 the new idea that ushered in the era of full employment and welfare reform was for power to be vested in the nation state and its policy expression was nationalisation.

In the 1980s the new idea that ushered in the Thatcher/Reagan era was for power to be vested in the free market and its policy expression was privatisation. In the mid-1990s the new idea that ushered in the Clinton/Blair era was for power to be vested in reformed institutions and its policy expression was modernisation.

Now the new idea is to vest power in the citizen and the community and to make its policy expression empowerment. Out of the debris of the global financial crash it can usher in a new era of progressive politics which fundamentally shifts the balance of power both in our society and our economy – towards the individual citizen. This is the new progressive cause.

Alan Milburn is Labour MP for Darlington and a former Health Secretary