Wednesday, November 26, 2014

Is State Capitalism Winning?

CAMBRIDGE – In the age-old contest of economic-growth models, state capitalism has seemed to be gaining the upper hand in recent years. Avatars of liberal capitalism like the United States and the United Kingdom continued to perform anemically in 2012, while many Asian countries, relying on various versions of dirigisme, have not only grown rapidly and steadily over the last several decades, but have also weathered recent economic storms with surprising grace. So, is it time to update the economics textbooks?

In fact, economics does not say that unfettered markets are better than state intervention or even state capitalism. The problems with state capitalism are primarily political, not economic. Any real-world economy is riddled with market failures, so a benevolent and omnipotent government could sensibly intervene quite often. But who has ever met a benevolent or omnipotent government?

To understand the logic of state capitalism, it is useful to recall some early examples – not the socialist command economies or modern societies seeking to combat market failures, but ancient civilizations. Indeed, it seems that, like farming or democracy, state capitalism has been independently invented many times in world history.

Consider the Greek Bronze Age, during which many powerful states, organized around a city housing the political elite, formed throughout the Mediterranean basin. These states had no money and essentially no markets. The state taxed agricultural output and controlled nearly all goods production. It monopolized trade, and, in the absence of money, moved all of the goods around by fiat. It supplied food and inputs to weavers and then took their output. In essence, the Greek Bronze Age societies had something that looked remarkably like state capitalism.

So did the Incas as they built their huge Andean empire in the century before the Spanish arrived. They, too, had no money (or writing); but the state conducted decennial censuses, built roughly 25,000 miles (40,000 kilometers) of roads, operated a system of runners to send messages and collect information, and recorded it all using knotted strings called quipus, most of which cannot be read today. All of this was part of their control of land and labor, based on centrally planned allocation of resources and coercion.

How is it that societies as disparate as the Greek Bronze Age cities of Knossos, Mycenae, or Pylos, the Inca Empire, Soviet Russia, South Korea, and now China all ended up with state capitalism?

The answer lies in recognizing that state capitalism is not about efficient allocation of economic resources, but about maximizing political control over society and the economy. If state managers can grab all productive resources and control access to them, this maximizes control – even if it sacrifices economic efficiency.

To be sure, in many parts of the world, state capitalism has helped to consolidate states and centralize authority – preconditions for the development of modern societies and economies. But political control of the economy generally becomes problematic, because those running the state do not have social welfare or optimal resource allocation in mind. The state capitalism of the Greek Bronze Age or the Inca Empire was not motivated by economic inefficiency; nor did it necessarily create a more efficient economy. What it did was help to consolidate political power.

At a deeper level, the real dichotomy is not between state capitalism and unfettered markets; it is between extractive and inclusive economic institutions. Extractive institutions create a non-level playing field, rents, and narrowly concentrated benefits for those with political power and connections. Inclusive institutions create a level playing field and give incentives and opportunities to the great mass of people.

But herein lies the problem for state capitalism: inclusive institutions require a private sector powerful enough to counterbalance and check the state. Thus, state ownership tends naturally to remove one of the key pillars of an inclusive society. It should be no surprise that state capitalism is almost always associated with authoritarian regimes and extractive political institutions.

This is not an endorsement of unfettered markets. The state plays a central role in modern society, and rightly so. Modern economic growth, even under inclusive institutions, often creates deep inequalities and tilted playing fields, endangering those institutions’ very survival. The modern regulatory and redistributive state can, within certain bounds, help to redress these problems. But the success of such a project crucially depends on society having control over the state – not the other way around.

To argue that state capitalism’s success proves its superiority is to put the cart before the horse. Yes, South Korea grew rapidly under state capitalism, and China is doing likewise today. But state capitalism emerged not because there was no other way to ensure economic growth in these countries, but because it enabled growth without destabilizing the existing power structure. The genius of China’s state capitalism is that it ensured the continued dominance of Communist Party elites while improving the allocation of resources, not that it alone could have provided price incentives to farmers and then managed liberalization of urban markets.

State capitalism will persist so long as existing elites are able to maintain it and benefit from it – even if economic growth ultimately stalls. And there is a good reason why it eventually will. Sustained economic growth presupposes inclusive institutions, because innovation – and the creative destruction and instability that it wreaks – depends on them. Extractive institutions in general, and state capitalism in particular, can support economic growth for a while, but only the sort of catch-up growth that South Korea experienced from the 1960’s to the 1980’s, before starting to transform its society and economy more radically.

As the low hanging fruit from catch-up growth is consumed, China, too, will be forced to choose between the economic and social freedom, innovation, and instability that only inclusive institutions can underpin and continued economic, political, and social control in the service of the elites who control the state.

Read more from our "The Clash of the Capitalisms" Focal Point.

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    1. CommentedKir Komrik

      Thanks for the balanced article,

      imo, both State Capitalism and American Capitalism can be summed up with two words; Epic Fail. It's just that we (in the States) don't realize it yet. It's not durable. It's unjust. It's unsustainable. And everything I've heard so far is just a tired variation on ideas that have been failing for over 100 years. It's time for fresh, new ideas that are truly original and not a rehash of old ones, imo. It's time for genuine global rule of law with General Federalism and Fiducial Economics, imo ... or a better idea if I hear one.

      - kk

    2. CommentedJohn Garrett

      The authors state that, in state capitalism, elites in the state exert power/control over the economy an society, "state capitalism is ... about maximizing political control over society and the economy. If state managers can grab all productive resources and control access to them, this maximizes control ..." However, Dr. Stiglitz and others have argued that, in the US, the flow of power is reversed; that is, the elites in the economy (the financial sector) have exerted their control over the state (and society). This suggests an alternative post-developing-country model for state capitalism.

    3. Commentedde Lafayette

      France, where I live, seems an unlikely candidate for state capitalism - but it is indeed one of the most prone EU countries for the role. Not long ago a Prime Minister was underscoring the necessity of French National Champions as a cornerstone policy to develop jobs.

      In fact, like most countries the larger part of any workforce is employed by small to medium large companies. So the "accident" of a communist country (China) changing sides to become a behemoth of capitalism bears some investigation, and even disbelief.

      No one can deny the Chinese success story, but to ascribe that success to State Capitalism is a step too far. The Chinese have been since time immemorial good entrepreneurs. It was a Chinese who first "discovered" both the African continent, the Arabian Peninsula, Iran and India to China's west and established trading ports - this during the 15th century - a bit before Columbus found the Americas on another voyage of discovery.

      Should we therefore be surprised of the Chinese resurgence? Not really. Should it be ascribed to State Capitalism? Not really, either.

      State capitalism in France, otoh, has been responsible for some very good policy initiatives. The first being to select for state development both a nuclear energy option and a hi-speed train transport system. Both of these industries are now world leaders in their domains.

      America, serial entrepreneur, renounced both such businesses. Much to its chagrin today. Its nuclear generation capacity is stagnant and no new plants are being built. (Thus wedding even further the US to carbon-based highly pollutant fuels.) And there is no challenge to high polluting commercial airliners from non-polluting hi-speed electric trains.

      These are only two examples where State Capitalism can undertake risky ventures in order to develop ... uh, National Champions (for lack of a better phrase). Where State Capitalism has worked wondrously in the US is, first, in aerospace technologies that took mankind to the moon. Then Arpanet that eventually evolved into the Internet we know today - the most important innovation in advancing our destiny since the Gutenberg bible was first printed.

      Are Western democracies therefore better off with State Capitalism? The answer to that question can only be, "It depends ...»

      It depends upon what national objectives we are trying to accomplish. We cannot simply depend upon markets to respond to a consumer need ipso facto. Markets often have to be prompted by a precursor effort to open the opportunity. State Capitalism thus works well to undertake such exploratory initiatives. But the lesson to be learned from Europe is that, once undertaken and proven valid, and then it is best for the state to get out of the business and leave it professionals.

    4. CommentedMehmet Ozcan

      There are always a balance between pure capitalism and state one. Optimizing the social welfare between these two extreme point is main problem of all governments...

    5. CommentedSergio Quirós Navas

      Countries that have embraced unfettered markets might have problems changing their path towards a "modern regulatory and redistributive state!. The problem we are facing in the US -an avatar of capitalism, as mentioned above- is that its powerful private sector is not checking the state but increasingly controlling it. This is, in my opinon, another example of the self-destructive nature of current capitalism: disruptive innovation is being interrupted by powerful incumbent firms who control, through lobbying, regulations that guarantee their hegemony. Elected representatives are spending "an ever-increasing amount of their time chasing donors for funds (...) as opposed to chasing citizens for votes" (
      And this kind of legalized corruption cannot possibly stop when incumbent firms and their lobbyists -the benefeciaries of the regulation- are controlling regulation.
      Thus, we have state capitalism in which power is in the hands of the political elite and we have the closest to unfettered capitalism available in the real world -the US- in which power is in the hands of big powerful corporations. How to get out of there?

    6. Portrait of Pingfan Hong

      CommentedPingfan Hong

      So far, in modern times, it seems we have not found a good example of catch-up growth in countries with unfettered market economy. All those emerging economies that have experienced a rapid catch-up growth in recent decades have more or less had certain degree of state capitalism. What is more important is whether these economies can eventually make a smooth transition into a democratic market economy when they complete the catch-up phase. A few East Asian economies did.

    7. CommentedJeff GE

      Since the West was developed first, all growths in emerging markets are catch-up growths, wether they are achieved through unfettered markets or state capitalism. This article offers little new to advance theory of the "inclusive" vs "exclusive" institutions. What is perhaps new and meaningful is that at least in the case of catch-up growth, unfettered market is not the only way and state capitalism is a viable alternative.

      This has nothing to do with wether I personally prefer one system vs another. It is about intellectual honesty.