The End of the Free Market or The End of State Capitalism?

Ian Bremmer will be on The Daily Show with Jon Stewart tomorrow. Below is my review of his new book:

Political risk guru Ian Bremmer examines the growing momentum of "state capitalism" in his new book The End of the Free Market: Who Wins the War between States and Corporations? Bremmer argues that state capitalism differs from free-market capitalism in that politics rather than profit is the main driver of decision-making. For this reason, it threatens to curtail free markets and the global economy. It is the latest chapter in the "rise of the rest," or the expansion of non-Western states in the international system.

Capitalism takes many forms but all of them can be distinguished by their "use of wealth to create more wealth, a broad enough definition to capture both free-market and state capitalism," Bremmer notes. In the free-market form of capitalism, the job of the state is to "enable" wealth generation by enforcing contracts and limiting the influence of moral bads such as greed—the latter can lead to market failures, which have occurred periodically since the Dutch tulip craze of 1637. Free-market governments attempt to ensure that the economic game is played fairly.

In contrast to free-market capitalism, the economy in state-capitalist regimes is dominated by the state agenda. "Forced to choose between the protection of the rights of the individual, economic productivity, and the principle of consumer choice, on the one hand, and the achievement of political goals, on the other, state capitalists will choose the latter every time," Bremmer explains. Continuing the sports game analogy, state capitalists control the referees as well as the main players.

Bremmer admits that state capitalism isn't new. He traces the first reference to an 1896 speech by Wilhelm Liebknecht, a founder of the Social Democratic Party of Germany. But due to recent questions regarding the merits of free markets after the 2008–2009 financial crisis, the need for job growth and economic stability in less-than-democratic regimes, and the growth of the economies and influence of state-capitalist countries, this form of capitalism is catching on worldwide.

While there is "no single model of state capitalism," its leading practitioners, China and Russia, "share a well-developed sense of risk aversion," having recently abandoned communism as their guiding philosophies. Other notable users of this model include energy-rich states, such as Angola, Iran, Kuwait, Malaysia, Nigeria, Saudi Arabia, the United Arab Emirates, and Venezuela. Another cluster of countries in this group, some of which have benefited from rising commodity prices, include emerging markets that have only tentatively committed to free-market principles, such as Brazil, Egypt, India, Indonesia, Mexico, South Africa, and Turkey.

Another way to identify a state-capitalist country is by looking at the use of four specific policy tools. One policy tool favored by state capitalists is the national oil (and gas) corporation (NOC), such as Gazprom of Russia, China National Petroleum Corporation, and the National Iranian Oil Company. NOCs like these own 75 percent of the world's crude-oil reserves. A second tool is the state-owned enterprise, such as China's First Automobile Works.

A third tool is privately-owned companies—so-called national champions—that are supported by the state to develop a "commanding position" in an economy. The Brazilian mining concern Vale, according to Bremmer, is a prominent example of a company that was coerced by its government to advance the state objective of stimulating the economy.

A final tool is the sovereign wealth fund (SWF), the largest of which includes the UAE's Abu Dhabi Investment Authority valued at $300–650 billion and Saudi Arabia's Monetary Agency valued at $430–500 billion. Many types of governments have SWFs but they "tend to be as transparent—or as secretive—as their governments," Bremmer writes, noting that Norway's Government Pension Fund is exceedingly open and accountable. Norway is an example of a country that has some state-capitalist trappings but is not in the state-capitalist camp. Similarly, the U.S. bailout of financial institutions was designed to "save the free market, not bury it," Bremmer notes. "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," he writes.

How do these tools threaten the free market? While Bremmer is careful not to predict a new Cold War, he does worry about fissures in the international system and state-capitalist support for undemocratic regimes such as Guinea. As the head of Eurasia Group, a political risk company, it is Bremmer's job to ask what if. He poses at least ten hypothetical scenarios in the book, including given the mutually assured economic destruction (or interdependence) between the United States and China, what happens if China closes the door?

While the phrase "The End of the Free Market" may capture public anxiety in America today, Bremmer should have called his book "The End of State Capitalism"—he bets that free markets will win the "war" with statists. First, state capitalism just doesn't have the same appeal as an ideology that communism had, it is "more a set of governing principles than a coherent political ideology." Second, state capitalism is actually a sign of domestic political vulnerability. It is a response to the risks countries face as they open up, which Bremmer detailed in his earlier book The J Curve. Meanwhile, free markets hold several advantages over their statist cousins: Most importantly, these systems better facilitate innovation and long-term growth.

Bremmer lays out several recommendations to ensure that free markets do indeed prevail. Most of these recommendations are just good common sense for America: keep markets open, invest in hard power, pick the right fights, and welcome world-class foreign workers. Bremmer is saying subtly that for America to continue to lead it should be strong, smart, and principled. In other words, it should stay true to its values.

"A Rallying Cry for CSR" - The CSR Journal

Here is my summary from our "Top Risks" event last month at Carnegie Council, published in The CSR Journal (Volume 5), which is edited by Michael Levine, co-chair of the ABA's CSR Committee. It is republished here with kind permission.

A Rallying Cry for CSR?

By Devin Stewart

One day after Google's bold decision last month to stop censoring its Chinese search engine and possibly quit its operations in China, Carnegie Council held its annual "Top Risks and Ethical Decisions" panel for 2010. Google's announcement and the earthquake that hit Haiti, two unexpected events with moral consequences, guided much of the panel's discussion.



The salience of the Google announcement was heightened by the foresight of Eurasia Group president Ian Bremmer who had placed U.S.-China relations as the 2010's top risk in terms of likelihood of change. It also highlighted the ethical challenges of doing business in China and globally as well as the positive leadership role businesses can play. Bremmer told me before he presented his full list of risks that he predicted Google would indeed pull out of China given the company's wide range of appeal—from technologists to free marketers to human rights activists—and the Communist country's inability to credibly guarantee security from further cyber-attacks. Google, along with at least 20 other companies, had been hacked in December, and it is widely believed the attacks were in coordination with a Chinese government agency that was attempting to gather information on dissidents. If personal information were compromised, peoples’ lives would be at stake. Business ethics are a very practical matter.

Bremmer wondered whether Google's moral stand might serve as a rallying cry for other companies to follow suit in China. Since Google's announcement, the company has been lauded, and the U.S. government has had to reverse its direction by stepping up its rhetorical pressure on China. In U.S.-China relations, the news came against a backdrop of tensions over possible UN sanctions on Iran, U.S. arms sales to Taiwan, and a Chinese test of a missile interceptor. It also occurs amid the longer-term trends Bremmer sees, specifically the acceleration of divisions between the world's developing and developed countries; free market economies and state capitalist economies; and the U.S.-led and multipolar worlds. Bremmer sees U.S.-China relations as the biggest risk for the year because "U.S. and Chinese economic systems are fundamentally incompatible. Compromise is a possibility but let's not obscure the question." He also noted that it isn't clear how the world will square China's global responsibilities given its limitations and societal pressures.

The Google episode in China also underscores the gap between short-term profit-seeking and longer-term ethical concerns for companies and countries alike. Without an expansion of rights and freedoms in China, the government risks hindering economic development. Without free press, for example, China simply cannot stem corruption. Above all, Google's move has expanded the options and the debate on the Chinese market. Carnegie Council's approach toward exploring international issues has been precisely that: to expand the scope of options and to encourage people to ask ethical questions. In line with Andrew Carnegie's vision, the Council aims to create and disseminate knowledge and understanding in order to facilitate societal transformation toward world peace. The "Top Risks" event is part of an ongoing series that brings companies and civil society together to examine business ethics issues, such as human rights policies, the role of the media, trust in the financial system, green job creation, and the fight against corruption.



Michele Wucker, head of the World Policy Institute, posed one of these potentially transformational questions. Considering the ecological limits of the planet, how much consumption is enough? China has just become the largest automobile market in the world, but do we really believe that every person in China can own a car? If the United States moves away from naked consumerism, what will take its place? And, how do we avoid policy solutions that hurt the poor? Wucker also pointed to the extreme poverty in Haiti, which exacerbated the devastation from the recent earthquake, highlighting the fact that risk is often increased when more than one factor is in play. Wucker predicted that finding sustainable levels of consumption and a balance between short-term and long-term gains would be the most pressing moral questions facing businesses for the foreseeable future.



A major obstacle to finding this balance, however, relates to the very nature of individuals and institutions, something that strategy+business editor Art Kleiner has been following for years. He identified at least three "meta risks" for 2010. The first is that although the stakes are higher than ever, it is unclear whether governments possess the management capacity to deal with the riskiest challenges, such as climate change and terrorism. The second is what he called "the risk of transitional capability," meaning that not only are changes in the global business environment occurring more rapidly than ever, it is also uncertain whether organizations can adopt the best practices in time to keep up with the changes. Moreover, transition implies unintended consequences and thus more uncertainty. Finally, bringing it to the personal level, there is a plausible scenario in which the world addresses these problems, but it will require individuals to change their behavior. It is becoming increasingly difficult for people to lead a "normal life," so what do you do? Kleiner asked. "To the extent that human survival requires individuals to change, will enough people be willing to do it? Maybe," he said.



"Integration" has already become the buzzword in business and policy circles this year. In applying this concept, Georg Kell, head of the UN Global Compact, explained that integration means companies must be best in class in their products and services but that isn't enough. Companies must also be able to deal with non-financial risk, such as environmental, social, and governance risks. Ethics is the floor or baseline for international business because "going global means going local," and globalization has therefore become a test case for the question, "Can we live with one another?"

Kell was optimistic about humanity's prospects because he believed the 2008 financial crisis brought ethics back into business decisions in at least three ways. First, it highlighted the need to move from short-term to long-term value creation. Second, it showed the importance of bringing non-financial issues into decision-making. Finally, he saw a general shared sense of ethics as underpinning these trends. His research has shown that there is a universal sense of fairness and justice around the world that can also be observed in religious traditions, philosophies, and law. Kell concluded by advocating for the "traditional values," such as cooperation, that made the free market work in the first place.

The panel seemed to agree that only human innovation can pave the path toward global salvation in the face of ecological, security, social, and economic risks. Thomas Stewart, Booz & Company’s chief knowledge officer, somewhat darkly concluded by encouraging people to find the courage to muddle through. He jokingly asked whether it is possible to avoid the future all together. Kleiner quipped, "There is always a way through by the skin of our teeth." The event also highlighted the large moral questions for the upcoming year, thus framing the fourth year of Carnegie Council's Workshops for Ethics in Business series programming, which is currently being expanded into a full-blown corporate membership program. If ethics matter to you and your organization, please contact us to get involved with this unique program.

Stewart is program director and senior fellow at Carnegie Council for Ethics in International Affairs and can be reached at dstewart@cceia.org

Ian Bremmer's Top Ten Political Risks for 2009

Eurasia Group's Ian Bremmer just released the firm's top ten political risks for 2009. We will feature a panel discussing the ethical implications of these risks with Ian Bremmer, Michele Wucker, and Art Kleiner next week, on Jan. 13, at the Carnegie Council. Sign up for the event at gpievents@cceia.org.

Here is how Ian summarizes the top risks for the year:

First, we’ll see more state intervention in the global economy. Second, that intervention will be both reactive and uncoordinated by a series of local, regional, and national political actors who have decidedly non-global (and in many cases non-market) views of the cost/benefit equations that attend their policy decisions. In short, politics will drive the global economy more directly, and more inefficiently, in the coming year than at any point since World War II.

Below, we present a truncated excerpt of the ten risks:

1. Congress - Political risks have historically been most important for economic outcomes in emerging markets, but that’s not so this year. The current financial crisis has created an unprecedented space for government interference in economic affairs within developed states, as well. Nowhere is that more true than in Washington.

2. South Asia Security - The security environment in India, Pakistan, and Afghanistan will deteriorate significantly over the coming year, and the United States and Europe will find themselves more directly involved in conflicts in all three states, with little benefit to show for it, by the end of 2009.

3. Iran/Israel - The likelihood of the United States launching strikes against Iran has diminished considerably over the past two years, due both to internal policy wrangling between Vice President Dick Cheney and others within the Bush administration and the election of Barack Obama as president. But 2009 is the critical year for conflict (both direct and through proxies) between Iran and Israel.

4. Russia - We enter 2009 with Russia in play in a way we haven’t seen in decades. The relevant comparison isn’t 1998, when the Russians engaged in default and devaluation but remained within the bounds of their existing political and economic system (as Lenin said, two steps forward, one step back). The history to consider is 1989—as key aspects of the Russian system could change for the worse.

5. Iraq - Frankly, Iraq at number five is a good news story. With about 140,000 American troops remaining on the ground and no serious evolution of the Iraqi political model, it’s a testament to the relative improvements of security that Iraq has managed to claw its way away from a risk that keeps the world on edge.

6. Venezuela - President Hugo Chavez has made a habit of miscalculation over the years, but this may be the big one. His plans for a referendum in the coming month to reform the Venezuelan constitution and abolish term limits (which would allow Chavez to run again for the presidency in 2012) show little likelihood of success. Then the Venezuelan president will have a real political fight on his hands.

7. Mexico - While Colombia’s President Alvaro Uribe has effectively won his country’s war against the drug cartels, the same can’t be said of Mexico’s President Felipe Calderon. The security situation there has worsened and is almost certain to deteriorate further over the course of 2009. Well armed and well financed narco-criminals have effectively declared war on the state of Mexico—increasingly singling out elected government officials, bureaucrats, and the armed forces and police for their attacks. As the government continues to rely on the military to go after the drug lords, the bloodshed will continue.

8. Ukraine - As I mentioned, Ukraine isn’t likely to spur the kind of direct military conflict we saw last August in Georgia. But it merits a slot in our top risks because of the government’s inability to deal effectively with the severe challenges posed by the current financial crisis and economic downturn—and one certainly not helped by its volatile relationship with Moscow.

9. Turkey - Speaking of internal distractions, Turkey is essentially defining the problem. The country has all sorts of factors in its favor—a diversified economy, strong demographics, an extremely favorable trade route geography, and solid ties with both western countries and its Middle Eastern neighbors. Yet the fight pitting secularists in the judiciary, military, and industry against Islamists in government is becoming a serious obstacle to economic advancement. And the AK party leadership, feeling that it increasingly carries the weight of popular support on its side, is unwilling to compromise—instead, casting out potential dissent from within the party (and losing critical bureaucratic competence as a result). To make matters worse, the AK party has long lost its reformist spirit and has embraced a more nationalist attitude, making it more difficult to find a solution to the thorny Kurdish question.

10. South Africa - Rounding out the top risks for 2009 is South Africa. Upcoming elections will dominate the news, but it’s more political context than electoral results that will cause concern. It’s pretty clear that the African National Congress (ANC) will keep its majority in parliament, though the emergence of a new splinter party will reduce its numbers. In principal, that’s not a bad development; popular concerns over the ANC’s abuse of power should be reduced accordingly. But the transition is going to be hard on the ANC leadership—with South Africa’s legislators having to accept the need to cooperate with political opponents, rather than using political influence to force would-be dissidents into line. The initial reaction is likely to be a lack of patience and tolerance, undermining public confidence in South Africa’s political institutions...and providing little comfort to investors.

Notice China instability, the Persian Gulf, and climate change are not on the list. Ian sees these as either red herrings or, in climate change's case, longer term developments.

East Asian Multilateralism: Fukuyama on Chinese democracy

I attended a fantastic event this week at the Japan Society in NYC with Francis Fukuyama and Kent Calder about their new book East Asian Multilateralism: Prospects for Regional Stability. Gideon Rose moderated.

One of the take away points that Fukuyama made was on Chinese democracy: It won't come anytime soon. The idea that development will push democracy in China doesn't work, he said. No one knows whether Chinese will accept the notion that the country has to embrace human rights to get what it wants. Fukuyama's concern is that gains from growth in China are so lopsided that democratic representation could mean a redistribution of wealth that would cancel out those gains. In any case, China could become the first country to democratize over the environment "because the are poisoning themselves." But he is optimistic for the long run.

In the book, Fukuyama, Calder, and their coauthors grapple with a changing security environment in East Asia where the traditional hub and spoke system has become outdated. What is dramatically different about the current situation, argues Fukuyama, is "the changed posture of South Korea... South Korea has shifted from being a bastion of anti-communism to seeking reconciliation and ultimate reunification with North Korea." Meanwhile, Korea-China relations have warmed. The South Korean spoke is "slowly rotting away."

To deal with new trends in China, South Korea, North Korea, and Japan, the United States needs to consider a multilateral framework for Asia, beyond the hub and spoke system. As Kent Calder put it, Northeast Asia is under-institutionalized, suffering from an organization gap. The areas of promise for institutionalization include the environment, energy, and finance.

Fukuyama outlined five options in his chapter:

Option one would be to maintain the current bilateral system and oppose multilateral institutions that do not include the United States, as Richard Armitage has argued.

Option two would be to lay the foundations for a multilateral containment barrier against China. He said a "sophisticated version" of this idea is contained in the project I ran at CSIS. In that project, Sherman Katz, Robert Fauver, and I argued for an East Asian economic community that would "incorporate as criteria for membership certain elements of good governance--for instance, rule of law, transparency, government accountability, and so on," as Fukuyama put it. You can read my proposal with Katz for these Comprehensive Economic Partnership Agreements (CEPAs) here from the American Interest.

Option three would be to create a five-power organization based on the six party talks. This is a proposal that Ian Bremmer and many others have proposed. My only critique about this concept is that it not take on too many sectors, as I argued in the National Interest here.

Option four would be to revitalize existing forums such as APEC in which the United States is a member. This is a concept that has been touted by many government officials in public but sometimes scoffed at in private. Many say that APEC is too big to get anything done.

The final option would be "re-Asianize" Japan by taking an existing forum such as ASEAN Plus Three and having Japan engage that forum in a more meaningful way. This idea was pushed by Kazuhiko Togo in the book and seemed to be Fukuyama's preferred route.

Dutch Disease and Democracy in Russia

I just got back from Tokyo, Kyoto, Osaka, Moscow, and St. Petersburg, completing a circumnavigation of the Earth.

One preoccupation in Russia was whether democracy is necessary for international legitimacy, prestige, and change. As one senior college student at St. Petersburg State University asked me: Do states need to democratize in order to globalize? I responded that democracy helps countries cope with the increased openness that is associated with globalization. I drew Ian Bremmer's J-curve on the blackboard (my interview with Ian about his book last year is here). Of course, the students wanted to know where Russia was on the J-curve.

Ian, a Russia specialist, devotes a whole section to Russia in his book: "Whether or not Putin's consolidation of power is the means to help Russia navigate the bottom of the curve and ultimately to make the transition from closed to open, left to right, remains to be seen."

Another big concern in Russia is the so-called Dutch Disease, which Russia has probably contracted. My presentation with Zhenia Bessonova in Moscow was about the effect of FDI on Russian industries. Companies that are competitive will respond to FDI by increasing efficiency while uncompetitive companies will exit. Russians are concerned about inflation and their heavily natural resource based economy.

Thinking about the bubble in the Shanghai real estate sector in China and the luxury condos between Bangkok and the airport in 1997, I noted that the road from the hotel to the airport in Moscow is dotted with new car dealerships--from Toyota to Ford to Audi. Is it bubbly in Russia too?