Article Commentary: The End of the Free Market: Who wins the war between States and Corporations?

Abstract

Leaders of authoritarian governments have embraced the capitalist system not only in order to maximise economic performance in their countries but also with the aim of promoting their political goals and furthering their political dominance. This practice gave rise to the phenomenon of state capitalism. In a period of severe crisis for the global capitalist system, state capitalism challenges free-market capitalism conceptually and practically: it offers an attractive alternative to leaders of emerging economies and it distorts capitalism's efficiency, thus undermining future recovery. Free-market states need to counter this double challenge by answering the call of smart regulation while practicing the tenets of free trade and open markets that they preach.

The rise of a new system

During the financial crisis and global recession, an enormous market meltdown that provided globalization with its first true stress test, political officials in both the developed and the developing world seized responsibility for decisions that are usually left to market forces-and on a scale not seen in decades. Governments around the world responded to the implosion of major financial institutions and key economic sectors with massive doses of state spending meant to kick-start growth and, in some cases, to bail out companies considered ‘too big to fail.’ States grabbed control of firms once considered industry flagships. They did all this because they believed it was necessary-and because no one else could do it.

A transfer of market power from capitals of finance to capitals of political power took place all over the world- from Shanghai to Beijing, Sao Paulo to Brasilia, Mumbai to Delhi, Sydney to Canberra, and Dubai to Abu Dhabi.

State capitalism is not the reemergence of socialist central planning in a twenty-first-century package. It is a form of bureaucratically engineered capitalism particular to each government that practices it. It's a system in which the state dominates markets primarily for political gain. As this trend develops, it will generate friction in international politics and distortions in global economic performance.

State capitalism: what it is and how it happened

There are two fundamental differences between free-market and state capitalism. First, policy makers don't embrace state capitalism as a temporary series of steps meant to rebuild a shattered economy or to jump-start an economy out of recession. It's a strategic long-term policy choice. Second, state capitalists see markets primarily as a tool that serves national interests, or at least those of ruling elites, rather than as an engine of opportunity for the individual. State capitalists use markets to extend their own political and economic leverage- both within society and on the international stage.

Those who practice state capitalism know, often from bitter personal experience, that command economies are bound to fail eventually, because governments can never direct supplies of scarce resources and attach values to goods and services as efficiently and intelligently as markets can. Instead of eliminating markets, they try to harness them for their own purposes.

To manage state capitalism, political leaders use a variety of intermediary institutions. The state doesn't always exert day-to-day control, but it has considerable direct influence over these tools. The most important of these are national oil (and gas) corporations (NOCs), other state-owned enterprises (SOEs), privately owned national champions, and sovereign wealth funds (SWFs). The presence of some of these institutions does not automatically make a country state capitalist. The government of Norway manages a sovereign wealth fund and owns more than 60 percent of StatoilHydro, the world's largest offshore oil and gas company. It's not the tools that count; it's how they're used. But countries that have all four of these institutions tend to be state capitalist.

The challenge

Herein lies state capitalism's greatest threat: Opportunity can enable dependence, and it's clear that an expanding number of Western companies and their governments are becoming ever more reliant on the willingness of all these new players to remain open for business. What happens when the Chinese leadership decides that its development strategy no longer depends on so much foreign investment and prefers instead to use all the tools at the state's disposal to support local companies and shelter them from foreign competition?

The Western financial crisis and global recession have left champions of free-market capitalism facing an increasingly skeptical international audience. Countries like state-capitalist China (and those with a relatively smaller stake in international trade, like India and Egypt) have taken a much less severe hit from the slowdown than free-market powers in America and Europe. With the “rise of the rest”, these and other developing states have cut into U.S. political, economic, and cultural hegemony over the past several years, and Washington has seen its great-power advantages begin to shrink, at least on a relative basis. If all these emerging powers embrace free-market capitalism, America might still hold a somewhat smaller piece of a much bigger pie. The risk for the United States-and for free-market democracies generally-is that distortions created by state capitalism will ensure that the pie isn't expanding quickly enough to accommodate all the new mouths it will soon be expected to feed. That will threaten not just standards of living, but eventually perhaps the security of the world's free-market democracies.

[O]ver the long term, the financial crisis has done considerable damage to America's ability to lead by example as a champion of free-market capitalism. The “rise of the rest” including several governments that practice state capitalism, will erode America's great-power advantages […] With the end of the Cold War and the collapse of communism, America appeared to have no credible rival. But the fall of the Berlin Wall did not signal the end of authoritarian government, and those who rely on tight political control still need an economic system they can use to ensure that they don't join the Bolsheviks atop the ash heap of history.

Now that the excesses of free-market capitalism have generated a market meltdown at home and a crisis abroad, the world's state capitalists find a more sympathetic audience, and the governments of other developing states now have a credible alternative model for success-one that appeals to their drive for political control.

Meeting the challenge

The economic meltdown of 2008–2009 made clear the need for better government, not less government, because it reminded us that investors and commercial strategists too often play for short-term gains and ignore longer-term risks. That's one reason why we shouldn't expect markets to regulate themselves and why intelligent (and limited) government intervention can help prevent market failures from generating shock waves through entire societies.

Because state capitalism is more a set of governing principles that a coherent political ideology, no two state-capitalist governments can ever fully align their interests. By its very nature, it's exclusionary; it promotes state goals at the expense of outsiders. Just as Cold War-era rivalries between Beijing and Moscow left them unwilling and unable to partner at U.S. expense, so today's Russian and Chinese governments, the world's most influential practitioners of state capitalism, have competing sets of economic interests.

There is more than one model of free-market capitalism-and Americans and Europeans often argue over the relative merits of their own version. The U.S/Anglo-Saxon model grew from mistrust of any system that gives government too much power. The European social-democratic model relies more on the state as guardian of the rights of the individual. Relatively speaking, it favors safeguards for works over protections for employers. This can slow growth rates over time, but it provides a wider social safety net when things go wrong. Different as they are, the two models share a core assumption: that the private sector, not the state, must be the primary engine of economic expansion if growth is to be strong and sustainable. Yet the difference between free-market capitalism and state-capitalism is a fundamental one. The former recognizes that government can help enable growth, while the latter asserts that government-managed growth can further empower government. For all the reasons outlined in this book, state capitalism limits the global free-market system's productive potential. That's why it's important that those who believe in free- market capitalism continue to practice what they preach.

The growing gulf between free-market and state capitalism has created a high-stakes competition between economic models, one that distorts the performance of the global economy and creates friction in international politics. Though this isn't a new Cold War, that conflict offers a useful metaphor for how the battle for free markets can be managed. For decades, the United States and the Soviet Union amassed nuclear arsenals large enough to destroy Earth many times over. The resulting stalemate, which came to be known as mutually assured destruction, helped prevent catastrophic conflict. Today, there are no ties more important for the future of the free market than those that bind America and China- the world's most powerful advocate of free trade and open markets and the largest and most influential practitioner of state capitalism.

State capitalism deserves some of the credit for this expansion, especially within countries like China and Russia that have grown from a very low base. But the broader story of the past three decades is one of command economies embracing capitalism and of states loosening their grip on economic activity. The strength and durability of recovery will depend on the willingness of those who believe in free markets to learn from the failures that triggered a crisis, to practice the kind of capitalism they preach, and to renew their commitment to the principles that have helped them prosper.