Should governments accept the dictates of markets? It’s the question raging across the econoverse in the wake of demands for austerity from bondholders.

But it’s the wrong question. The right question is: are organizations and markets making decisions that help make people, communities, and society better off in the long run, by allocating their scarce resources to the most productive uses? The correct role of governance is to shape the decisions of markets, by breathing life into social preferences and expectations. Here’s what I mean by that. Once upon a time, markets “wanted” indentured servitude, debtors prisons, and child labor. But those decisions were unacceptable to society, and so governments took on the challenge of shaping them, reforming markets by preventing them from choosing those options.

The key word is reform. It’s shorthand for “macro institutional innovation” — creating new institutions that govern countries, economies, and regions.

Today, its increasingly clear that markets and companies aren’t making the right decisions — and that without reform, they won’t. Markets have been misallocating resources for decades, minimizing welfare gains. Consider the trillions spent on bailing out banks in just the latest housing bubble, for example. And those are a drop in the bucket compared to how inefficiently markets allocate, say, oil. The eventuality that oil will run out isn’t priced into the market, just the marginal cost of producing the next drop.

What happened? How did our most basic economic tools become so blunted? There’s much hand-wringing amongst macroeconomists about the failures of theory and models. I think the real failure is elsewhere: in real-world innovation. Though economists and management thinkers extolled the virtues of innovation repeatedly, firms were just mastering low-level product, service, and technological innovation. Ironically, it was the most powerful kind of innovation that was left ignored, and so simply stopped happening: institutional innovation.

The first half of the 20th century was a golden age, a period of intense institutional innovation. Simon Kuznets laid down the foundations of GDP. At Bretton Woods, world leaders built a global exchange rate regime. The idea of global governance and justice was formalized in international codes of law and tribunals. The groundwork was dug for new kinds of organizations, like 501c‘s, formalized in the 50s.

But the latter half of the 20th century was a relative dark age, a period of institutional disinnovation. The global exchange rate regime laid down at Bretton Woods simply fell apart. GDP, built for a world of factories, consumer goods, and superhighways, was never updated to measure the costs and benefits of a radically interdependent, post-industrial, information-based economy. New kinds of organizations languished, and the idea that the “corporation” was the terminus of organizational evolution became dogma. Therein lies the problem: our economy’s trying desperately to shift past the industrial era, but our macro institutions are a rusting, creaking iron cage, trapping us in it.

Today, new reformers can kickstart radical macro institutional innovation. And It’s not just for policy makers. In the 21st century, governance is no longer just about governments. What’s different, now, is that smart entrepreneurs, investors, and companies can DIY it. Here are four areas where it’s needed most, fastest:

New measures of national income. GDP is outdated; inaccurate, invalid, and unreliable. Better measures of national income that count real costs (like pollution) and benefits (like health) are what will shape better behavior from organizations and markets.

Measures of well-being. GDP is a measure of income. What’s missing from that picture? Well-being, of course. More income doesn’t automatically make everyone better off all the time, in the same ways. Without measures of well being to live up to, no better behavior is likely to ever flow from organizations and markets.

New currencies. A currency is an especially cruel a form of collective punishment, an implicit tax. In the aftermath of inevitable, regular-as-clockwork financial crisis, everyone holding a currency suffers, whether or not they had anything to do with said crisis. When currencies are created that are independent of countries and regions, people will the choice to escape the bone-headed organizations and markets within them. That, in turn, will set incentives for better behavior. Creating “product”? Stop. Create a currency instead.



New measures of returns. What counts as a “return,” anyways? Increasingly, as we’ve recently discussed, bleeding edge investors are beginning to develop measures of returns to people, communities, and society. They provide a more nuanced, sophisticated picture of the value a firm has actually created — or a market allocated — than mere financial returns (“profit”). Better behavior from organizations and markets is ineluctably tied to better measurements of what is returned from them.

Want to be a radical innovator? Be a reformer. Today’s great challenge is reshaping the macro institutions of the global economy. That is what the transition to the 21st century demands. Right now, what we’ve got is a set of macro institutions left over from the industrial era. They’re obsolete and out of touch. They are what let firms and markets to behave exactly the same way as a century ago. What it means to transition to a post-industrial economy is to have built macro institutions that matter to people — not just machines.

It is the countries, companies, and people that can build them who, I think, will reap tomorrow’s greatest rewards. Why? Because they will be shaping and molding the next tomorrow’s high ground. And there’s no source of advantage greater than that.