State Capitalism

THE RISE OF STATE CAPITALISM: GOVERNMENT-ENGINEERED GROWTH VS. WELL-REGULATED FREE MARKETS.

The recent economic liberalizations recently announced by our PM have invited mixed reactions. Some claimed they have not gone down well with the population. The removal of the 30% equity requirement for companies en route to listing is a contentious issue. Some say, PM Najib wants to be popular. While removing the requirement, the PM has also announced the formation of Ekuinas- essentially a fund manager investing in deserving Bumi companies. (?)

Who are to carry out these economic initiatives announced by the PM? If his pronouncements regarding the downsizing and perhaps winding up some GLCs are taken as clues, then he is entrusting the private sector as principal agents. He believes in the market system. But will they be allowed to operate under a regime of a well regulated free market system? A well regulated system means the institution of the rules of law, transparencies, commitment in ensuring enforceability of contracts and an adoption of a supporting role by the government which are designed to assist rather than impede economic performance.

If he remains consistent, then his economic initiatives run counter against the current conventional economic strategy- that of using state capitalism as transmitters of economic initiatives. In so far as his economic initiatives lead to the emasculation of state capitalism and with it, the weakening of state controls, his policies should be warmly embraced by supporters of a liberal economic system.

In an interview with Milton Friedman, he said: the prime movers of economic prosperity are the private sector. His beliefs in the efficacy of the private sector, liberal economic system, freedom of choice remains unshaken.

Let's see what the PM is up against.

In recent times however, there has been a resurgence of Keynesianism in the form of a revived eminence of government as economic engine. In America it is Congress which provides the USD787 billion stimulus package. In Malaysia, parliament passes the rescue package. The first was the RM7 billion package followed by a second of RM60 billion.

The present world recession and troubled domestic economies make political leaders and policy makers predisposed and naturally inclined to see big government as the sure fire solution to economic ills. There is now a ready acceptance that big government is good. This belief accordingly finds expression in the oft quoted assertions that the way to go is by way of public wealth, public investment, and public enterprise. All of these are creations of big government. as Over the past several years, an era of state capitalism has dawned, one in which governments are again directing huge flows of capital in their economies.

But there is a flipside of state capitalism. It justifies bigger government and with bigger government comes deeper bureaucracies and extensive politics. Indeed, as noted by Ian Bremmer in a recent article in Mckinsey Quaterly, under State capitalism governments can manipulate market outcomes for political purposes. Governments embrace state capitalism because it serves political as well as economic purposes. They enter the market not because it's the most efficient means of generating prosperity. With enlarged governmental role, vast financial resources are placed within the control of state officials. Hence state capitalism necessarily allows government officials and bureaucrats access to cash. At the same time, access to purse strings helps those who control the levers of government safeguard their domestic political capital.

As pointed out by Bremmer, state capitalism also stems the rise of liberal democracies, because to varying degrees it hampers the flow of ideas, information, people, money, goods, and services within countries.

The new importance of the state had become obvious well before the onset of the current crisis. Energy markets provide a good example. As pointed out in the same article by Bremmer:-

The world's 13 largest oil companies, measured by the reserves they manage, are now controlled by governments. Saudi Aramco, Gazprom (Russia), China National Petroleum Corporation (CNPC), National Iranian Oil Company (NIOC), Petróleos de Venezuela (PDVSA), Petróleo Brasileiro (Petrobras), and PETRONAS (Malaysia) are all larger than any international oil company.

Exxon Mobil, the largest of the multinationals, ranks 14th in the world. Collectively, multinational oil companies produce just 10 percent of the world's oil and gas and hold about 3 percent of its reserves. State-controlled companies now are in charge of more than 75 percent of global crude oil reserves.

While Multinationals continue to hold competitive advantages in development and production of deep-sea and other technically difficult projects, this advantage is eroding as the better-managed of the national champions learn from the industry leaders.

In Malaysia, PETRONAS prides itself as being competitive in overseas markets and says equally proudly, that it derives 40% of its revenues from export earnings. The people in PETRONAS cannot be faulted into thinking they are 'government'.

The story extends well beyond energy. Across a broad range of economic sectors, China and Russia are leading the way in the strategic deployment of state-owned enterprises. Other governments have begun to follow their lead. In defense, a growing number of emerging-market governments—power generation, telecom, metals, minerals, and aviation—not content with simply regulating markets, are moving to dominate them.

The global recession has accelerated the trend of state involvement in markets as governments around the world spend billions to stimulate growth and bail out vulnerable domestic industries and companies. As governments become increasingly intrusive in the market, there is a need to build consensus behind the establishment of new rules for financial institutions and more reliable oversight and procedures. You can't have unfettered intrusion without owning up to responsibilities. Governments may be reluctant state capitalists, forced into the role by political necessity, but the effect is the same: a bigger dose of politics in the economy.

With bigger doses of politics into the economy, that will send signals of government activism in the economy. Will this mean more regulatory powers vested in the hands of officials and politicians? Will they become bigger napoleons graduating from the little napoleons?

Because political factors unique to each state will determine the response to each domestic economic slowdown, countries with relatively strong political fundamentals will have a better shot at a quick recovery. Accordingly, much will depend on strong political fundamentals. What are they?

For over 30 years China has undergone tremendous economic advancements. That performance has given the Chinese Communist Party elite deep reserves of political capital, and a surge of national pride has helped the leadership ease public fear, fend off criticism, and shift blame for the slowdown onto corrupt capitalists. Given the vast sums its government can spend on fiscal stimulus, China will likely emerge from the global recession before most of the developed world.

This will further persuade the Chinese leadership that state control of much of the country's economic development is the most reliable path toward prosperity—and, therefore, domestic tranquility. The example in China will encourage the rise of state capitalism more.

But it is also true that when political considerations are given preponderant weight, it can also lead to abuses and uncertainties. Just look at what is happening across the world. In USA, as Democrats and Republicans in Washington, fractious lawmakers in Brussels, the champions of competing industry groups in Beijing, the leaders of powerful Kremlin factions in Moscow, and political officials in Delhi make more of the key decisions on how, when, and where assets will be valued and resources allocated, we're bound to see a higher level of policy incoherence that will weigh on future growth.

There are plenty of good reasons for political leaders to intervene these days in domestic economies. Very often they are justified on grounds of wanting to offer better-crafted rules for future flows of cash, goods, and services. But this acknowledgment cannot obscure the fact that markets do these things more efficiently and effectively than politicians do.

Rise of economic cronyism.

Politicians do the following things. They will want to rescue their domestic economies and the way they do that, is not always economically rational. They're primarily interested in bolstering their personal stores of political capital by serving and protecting their most powerful constituents—be they local voters, political benefactors, or powerful industries and interest groups. They will have plenty of opportunities to favor selected and crony companies at the expense of nimbler and more efficient competitors.

Demand for more subsidies.

Politicians will turn increasingly toward a familiar and reliable tool: subsidies. Never mind that many governments may no longer be able to afford them, political officials will protect well-connected local companies, particularly while access to cash is at a premium, depriving the less-well-connected domestic firms of their competitive edge. In some countries like Russia, the government has used state-controlled commercial banks to bail out preferred companies.

Finally, the financial crisis will encourage governments around the world to reshape their regulatory environments, changing the rules of the game for both foreign and domestic companies. Danger sets in when the ground rules are changed regularly and economic decisions are difficult to make under conditions of uncertainties.

Will state capitalism completely reverse free trade progress? That's highly unlikely. The global financial crisis has not proven that government-engineered growth can outstrip the expansion of well-regulated free markets over the long term. Efficient allocation of resources is best left to the market system and to private enterprise.

When political considerations outweigh economic rationales, costs may be high. States like China in which state capitalism is dominating pays for its economic progress with high environmental costs. Russia's reliance on Vladimir Putin at the expense of credible governing institutions put such a country's economic resilience to the test.

Free trade and capitalism do not depend on the wisdom of political officials for its dynamism. That's the primary reason it will almost certainly withstand the state capitalist challenge. Attributing omnipotent wisdom on political figures and the state breeds precisely the fatal conceit opposed FA Hayek.

But the current global financial crisis will ensure the growth of state capitalism over the next several years. The arc of its trajectory will depend on a range of factors: any wavering of faith in the power of free markets, our capacity to kick-start our economic growth, the ability of governments dependent on oil exports to withstand the pain inflicted by lower prices, our ability to create jobs, and dozens of other factors.

In the meantime, corporate leaders and investors must recognize that market system is no longer the unchallenged economic paradigm. Politics will have a profound impact on the performance of markets for many years to come. The survivors are those who adapt.

Acknowledgment: The main ideas for this article were spawned by a recent article by Ian Bremmer in Mckinsey Quarterly. I have used them liberally and have made suitable adaptations to local scenario.