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Statist Strongmen Putin-Xi See History’s Capitalism Clash

August 05, 2014

Statist Strongmen Putin-Xi See History’s Capitalism Clash

Russian President Vladimir Putin is greeted by Chinese President Xi Jinping before the opening ceremony at the Expo Center at the fourth Conference on Interaction and Confidence Building Measures in Asia (CICA) summit in Shanghai on May 21, 2014. Photographer: Mark Ralston/AFP via Getty Images

History isn’t over, after all.

Back in the summer of 1989, American political scientist Francis Fukuyama wrote an influential essay in The National Interest, arguing that the Cold War’s demise meant “the end point of mankind’s ideological evolution” had been reached with an “unabashed victory of economic and political liberalism.”

Twenty-five years later, the global divide over how to organize an economy is back. Free-market U.S.-style capitalism, bloodied by the global financial crisis, is again being challenged by the apostles of a robust government economic role known as state capitalism. And this time, the tidy 20th century separation between rival economic blocs has been replaced with a confounding web of cross-border ties.

In China, where President Xi Jinping seeks to complete his country’s return to global prominence, the government promotes domestic technology companies by unleashing investigations of their U.S. competitors, including Redmond, Washington-based Microsoft Corp. In Russia, the imposition of European Union and U.S. sanctions over the conflict in Ukraine already is claiming as collateral damage the operations of foreign businesses such as London-based BP Plc and Siemens AG of Munich.

“No country is an island,” Bill Gross, chief investment officer of Newport Beach, California-based Pacific Investment Management Co., the world’s biggest manager of bond funds, tweeted on Aug. 1. “Global trade & growth will be affected by Russia/EU/U.S. trade war.”

‘Illiberal State’

State capitalism isn’t confined to China and Russia. The emirates of the Persian Gulf have long fused state and bazaar, while some specialists even see countries such as Brazil and Turkey as deserving of the label.

The latest convert is Hungary, where Prime Minister Viktor Orban said on July 28 he wants to abandon liberal democracy in favor of an “illiberal state,” citing Russia and China as examples.

Territorial Disputes, Malignant and Benign

“They’re not looking at the U.S. as a role model anymore,” says Aldo Musacchio, a professor at Harvard Business School in Boston and author of “Reinventing State Capitalism.” “Everyone is looking at China.”

Putin and Xi are the world’s best-known advocates of state capitalism. It’s a term that experts sometimes disagree about yet generally it refers to authoritarian governments that exercise substantial influence over their economies.

Today’s state capitalism bears little resemblance to the Soviet era, when armies of bureaucrats set unforgiving targets for factories with no regard for market reality. Instead, state capitalists track global interest rates and equity indices, sniffing out profits with a zeal that would be familiar in the corridors of Goldman Sachs Group Inc. (GS:US) in New York.

State Connections

In China, while the Communist Party maintains a monopoly on political power, it has long since abandoned Marxist ideology in favor of a vigorous commercial faith. Russia, too, has lost its communists; their heirs are politically connected oligarchs who move freely between a nominally democratic public sphere and the world of commerce.

President Vladimir Putin holds sway over “a business community whose wealth and power are based entirely on their connections to the state,” said Jeffry Frieden, a professor of government at Harvard University in Cambridge, Massachusetts, and author of “Global Capitalism: Its Fall and Rise in the Twentieth Century.”

These economic systems use market forces to discipline state-owned firms without surrendering control of their nation’s fate to global investors or foreign corporate rivals.

‘National Champions’

The “national champions” that result -- such as Rosneft OAO in Moscow and the Industrial & Commercial Bank of China in Beijing -- aren’t the lumbering government entities of the past. They boast the trappings of private enterprise: modern professional management, boards of directors, outside auditors and institutional investors. That keeps them somewhat accountable -- and often quite profitable: ICBC made almost $43 billion in profits last year.

“You have to run your crown jewels in a somewhat efficient way, to provide you with fiscal resources and dividends,” said Musacchio.

Still, U.S. companies overall dominate global profitability tables. Six of the top 10 companies measured by return on assets are American; just one is Chinese and none hail from Russia.

Policy Lever

In Russia, the world’s biggest energy exporter, Putin has long viewed the nation’s natural resources as a foreign policy lever. He twice shut the taps on Russia’s gas pipelines to Ukraine, most recently in 2009, and partially renationalized the oil industry, sometimes at the expense of Western companies such as Royal Dutch Shell Plc of The Hague and BP.

China has more than 100,000 state-owned enterprises, holding assets valued at roughly $13 trillion, according to a January study by the Chicago-based Paulson Institute. On top of the anti-monopoly investigation of Microsoft and San Diego-based Qualcomm Inc., Google Inc. (GOOG:US) and Apple Inc. have been criticized by state media for allegedly cooperating with a U.S. spying program.

The Obama administration has viewed Russian and Chinese economic policies as a danger to U.S. national interests, an alarm that was sounded by former Secretary of State Hillary Clinton last month.

“We have to begin to take on state capitalism because it’s one of our biggest competitive threats,” Clinton, the Democratic frontrunner in the 2016 presidential race, told a Council on Foreign Relations conference.

‘Competitive Neutrality’

President BarackObama took office in 2009 at a time when free-market capitalism, sullied by the 2008 global financial crisis and the worst economic downturn since the 1930s, had been challenged by an increasingly popular state-centric alternative.

The State Department started targeting what it considered anti-competitive behavior by state-owned firms in response to a parade of U.S. companies complaining that they were being harmed by state-backed rivals -- and not just in China.

State-owned companies were “an increasingly important threat to American industry,” said Robert Hormats, vice chairman of Kissinger Associates Inc. in New York and a former undersecretary of State for economic growth, energy and the environment.

The goal wasn’t to encourage privatization but “competitive neutrality,” meaning that whatever support government-owned firms enjoyed shouldn’t distort trade or provide an unfair advantage, Hormats said.

Losing Ground

Though the problem hasn’t gone away, market-oriented capitalism has regained some lost ground. Five years ago, 55 Chinese companies made the list of the world’s 500 largest enterprises, as measured by market capitalization. Today, only 35 Chinese names qualify while the U.S., which held 159 places in 2009, has rebounded to 205 spots, according to data compiled by Bloomberg.

Eight of the 10 largest companies in the world measured by market capitalization are American, including Apple of Cupertino, California, Exxon Mobil Corp. of Irving, Texas, and Google of Mountain View, California.

The popularity of Russian and Chinese-style strongman capitalism does have its limits. Russia for decades has been a petro state, with oil and gas accounting for 70 percent of exports, half of government tax revenue and about 17 percent of the gross domestic product in 2012, according to the European Bank for Reconstruction and Development in London.

Contraction Expected

That dependence on energy for economic growth served Russia well during the commodity super-cycle that ran from 2000 to 2008, when the country experienced 7 percent average annual economic growth and an expansion in the middle class.

A Snapshot of Ukraine's Past and Future

Yet Russia’s economy was decelerating even before the U.S. and EU imposed economic sanctions over the troubles in Ukraine. BNP Paribas of Paris expects the country’s economy to contract 2 percent in 2014 and 3 percent the following year.

“Russia doesn’t make anything,” Obama told the Economist magazine in a recent interview. “I think history is on our side.”

China has challenges of its own, starting with its sprawling state-owned enterprises. Promised reforms by Xi’s government would “level the playing field between private and public sectors,” according to the latest review of the economy by the International Monetary Fund in Washington.

Global Competition

Xi plans to open additional industries, especially services such as health, finance and logistics, to global competition as part of the most sweeping economic changes in a generation. China’s hopes of developing home-grown products with global appeal, however, are threatened by tight restrictions on the flow of information that innovation requires. Of the 50 largest global technology companies by market capitalization, only two are Chinese, according to data compiled by Bloomberg.

The state sector’s financial performance also has deteriorated since its 2007 peak. From a high of 9 percent that year, the profit margin fell to 5.6 percent in 2012, the most recent Ministry of Finance data available show. The sector’s return-on-assets has shrunk over the same period, according to the Paulson Institute.

Complicating China’s economic to-do list is the political challenge. The country of 1.4 billion people is attempting to do something no authoritarian state has managed: join the ranks of the world’s most developed economies while maintaining an iron grip on political power.

Along the way, China’s leaders will still need foreign investment and joint ventures to improve the quality of the home team. Global competition will “enable China to do better in terms of economic development,” said Joseph Cheng, a political science professor at the City University of Hong Kong.

China and Russia both view themselves as great powers that have been temporarily sidetracked by the U.S., Europe and Japan. And they have no reservations about charting their own path. The current era of geopolitics is a far different world than Fukuyama once envisioned.

To contact the reporters on this story: Brian Bremner in New York at bbremner@bloomberg.net; David J. Lynch in Washington at dlynch27@bloomberg.net

To contact the editor responsible for this story: Steven Komarow at skomarow1@bloomberg.net John Brecher, Mark McQuillan


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