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State capitalism
Thursday, 31 May 2012 21:29

With Europe now in recession, and the US still muddling through, many observers are now preaching the merits of "state capitalism" as against liberal capitalism.  But as the Economist argues convincingly in its special report of 21 January 2012, state capitalism also has many shortcomings, especially for advanced countries which depend on innovation-driven growth.  In fact, state capitalism serves more to strengthen the state and its elite members, rather than to serve the welfare of citizens and society, and thus may contain the seeds of its own destruction.

State capitalism seems like an oxymoron.  It describes a blending of the powers of the state and the powers of capitalism.  It is difficult to define because there are some very different examples.  But state capitalism has come to the fore over the past decade or so with the rise of state-owned or controlled enterprises.  These enterprises are backed by the state, but behave like private-sector multinationals.  The leading practitioner of state capitalism is China, but Russia and some Gulf States are also active. 

There is a long history of state capitalism.  Rising powers have always used the state to kick-start economic growth or at least protect fragile industries.  Think of the US after the war of independence.  George Washington's treasury secretary Alexander Hamilton introduced a plan to get the young economy going by protecting its infant industries with tariffs. 

Then there are the cases of Germany in the 1870s, or Japan and Korea in the 1950s.  Even Britain, the crucible of free-trade thinking, created a giant national champion in the form of the East India Company.  Today, the advanced world has many remnants of state capitalism -- for example, the French government owns 85% of EDF, an energy company, the Japanese government has 50% of Japan Tobacco, and the German government 32% of Deutsche Telekom.

More recently, the failure of Boris Yeltsin's post-Soviet privatization convinced many emerging countries of the benefits that state capitalism could provide in terms of stability.  Communist apparatchiks-turned-oligarchs had grabbed chunks of the economy.  Between 1990 and 1995, Russia's GDP dropped by a third.  Male life expectancy shrank from 64 to 58.  Once-captive nations broke away.  In 1998, the country defaulted on its debt.  So Vladimer Putin reasserted direct state control over strategic industries and brought the remaining private-sector oligarchs to heel.

The collapse of the Soviet Union provided a great lesson to the Chinese Communist Party which fears for its survival.  Thus, China privatized small state-owned enterprises (SOEs) while strengthening its hold over the large ones which are becoming wealthier and more powerful (even though the state sector only accounts for one-third of China's GDP compared almost all of it a few decades ago).  The Chinese state is the biggest shareholder in the country's 150 biggest companies and guides and goads thousands more.  In particular, it directs money to favored industries and works closely with Chinese companies overseas.  Thus, China and Russia have developed their formula for state capitalism only in the past decade.

State capitalism can claim some of the world's most powerful companies.  The 13 biggest oil firms, which between them have a grip on more than three-quarters of the world's oil reserves, are all state-backed.  So is the world's biggest natural-gas company, Russia's Gazprom.  The Chinese state owns 90% of the shares in PetroChina and 80% of those in Sinopec 

But successful state firms can be found in almost any industry.  China Mobile is a mobile-phone goliath with 600 million customers.  Saudi Basic Industries Corporation is one of the world's most profitable chemical companies.  Russia's Sberbank is Europe's third-largest bank by capitalization.  Dubai Ports is the world's third-largest ports operator.  The airline Emirates is growing at 20% a year.

State companies make up 80% of the value of the stockmarket in China, 62% in Russia and 38% in Brazil.  They accounted for one-third of the emerging world's foreign direct investment between 2003 and 2010, as well as a growing proportion of the very largest firms: three Chinese SOEs rank among the world's ten biggest companies by revenue, against only two European ones.  Then there is a long list of national champions that operate in the shadown of the state, including China's Geely in cars, Huawei in telecoms equipment and Haier in white goods.

State capitalists are also managing huge pools of capital in the form of sovereign wealth funds like the Kuwait Investment Authority, the Abu Dhabi Investment Authority, China's SAFE Investment Company and China Investment Corporation.

One should never underestimate the political dimension of state capitalism.  The Chinese Communist Party has cells in most big companies (private and SOEs) complete with their own offices and files on employees.  It controls the appointment of captains of industry, holds meetings that shadow formal board meetings and often trump their decisions.  The Communist Party's "organization department" appoints all senior figures in China Inc.  In 2004, it reshuffled the heads of the three biggest telecoms companies.  In 2009, it rotated the bosses of the three biggest airlines, and in 2010 did the same to the chiefs of the three biggest oil companies.

In Russia, the state holds huge chunks of the shares of the country's biggest and most strategic companies, including Transneft, a pipeline company, Sukhoi, an aircraft-maker, Rosneft, Sberbank, Unified Energy Systems, an electricity giant, Aeroflot, and Gazprom. 

How does state capitalism perform?

The evidence shows that SOEs use capital less efficiently than private ones, and grow more slowly.  In many countries, the coddled state giants are pouring money into fancy towers at a time when entrepreneurs are struggling to raise capital.  Also, SOEs can be good at copying others, partly because they can use the government's clout to get hold of their technology.  But as they have to produce new ideas of their own, they will become less competitive.  State capitalism works better in areas like infrastructure than in consumer goods.

State capitalism only works well when directed by a competent state.  Many Asian countries have a strong mandarin culture, whereas South Africa and Brazil do not.  And everywhere state capitalism favors well-connected insiders over innovative outsiders.  In China, highly educated princelings have taken the spoils.  In Russia a clique of "bureaugarchs", often former KGB officials, dominate both the Kremlin and business.  Thus, state capitalism produces corruption, cronyism, inequality and eventually discontent -- as the Mubaraks' brand of state capitalism did in Egypt. 

But there is little chance of reforming SOEs as they provide comfortable berths for leading politicians and their children and hangers-on.  Indeed, state capitalism reinforces corruption because it increases the size and range of prizes for the victors.  The ruling cliques have not only the government apparatus, but also huge corporate resources at their disposal.  By turning companies into organs of the government, state capitalism simultaneously concentrates power and corrupts it.

Managing state capitalism's contradictions when the economy is growing is one thing; doing so when it hits a rough patch quite another.  How can the state regulate the companies that it runs?  How can it stop through good money after bad?  How can it be innovative when innovation requires the freedom to experiment?  

One thing is clear about state capitalism, which is that politicians have far more power than under liberal capitalism.  Authoritarian regimes can restructure entire industries athe stroke of a pen.  In China, Communist Party hacks can find themselves running the country's biggest companies.  There are currently 17 prominent Chinese political leaders who have held senior positions in large SOEs.  Concersely, 27 prominent business leaders are serving on the Party's Central Committee.  In these circumstances, how can you prevent governments using companies as instruments of military power?  And SOEs can also wield a lot of influence over their supposed political masters.

In conclusion, state capitalism has to be seen clearly for what it is.  It is an instrument of non-democratic governments like China, Russia and Gulf States to strengthen the state and make it less vulnerable to democratic pressures.  It is also a mechanism for the elites of these countries to get their hands on the spoils of economic development.

The long term survival of these SOEs depends on them becoming more efficient and profitable such as through privatization, but that would mean losing control.  There are too many cases where SOEs are very inefficient and have not been able to strengthen the state, and where they ultimately fail, like in Egypt, Syria or the former USSR.  In short, the jury is still out on the final destiny of state capitalism. 


The Economist.  "The rise of state capitalism".  21 January 2012.



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