Davos dispatch: Free market vs. state capitalism

With this week's Davos edition of The Economist, the concept of state capitalism has now graduated from provocative idea to conventional wisdom. The magazine's report on this trend is a must-read.

What exactly is state capitalism? No one knows better than Chinese and Russian leaders that communism doesn't work. They know from personal experience that the state can't engineer lasting long-term growth and that markets are crucial for the rising standards of living that autocratic governments must deliver if they are to remain in power. But these leaders also know that if they simply let markets decide who wins and who loses, they deny themselves control of the money needed to keep people in their jobs and off the streets in times of trouble -- and they risk enriching and empowering some who might use their newly won wealth to challenge for political power.

The goal of state capitalism then is to allow the state to play the largest possible role in controlling the wealth that markets generate within their borders. China, in particular, has used state-owned companies, privately owned national champions, sovereign wealth funds, and state influence over bank lending to build a powerhouse economic engine that its political leaders continue to drive.

This is a subject close to my heart. In fact, I've been invited to take part in an online debate on The Economist's website in which I argue that state capitalism is not a viable long-term alternative to the free market variety.  In general, I was impressed with The Economist's excellent comprehensive coverage of this trend.

Until the very end of its report.

The Economist argues that "both for their own sake, and in the interests of world trade, the practitioners of state capitalism need to start unwinding their huge holdings in favoured companies and handing them over to private investors. If these companies are as good as they boast they are, then they no longer need the crutch of state support.

It's no surprise that The Economist would argue against the use of this system. Pretty much everyone here at Davos who is not part of the Chinese, Russian or Gulf Arab delegations would agree. I know I do. But The Economist is telling China's leaders to immediately begin shedding the system that has made their economy the second largest in the world while helping them maintain their monopoly hold on political power-and to opt instead for the brand of capitalism blamed for the financial crisis, the global recession which followed, America's economic malaise, and the Eurozone's current crisis of confident. While we're at it, why don't we ask the Chinese leadership to become a "responsible stakeholder."

As I've said, I agree entirely with the larger point that state capitalism is not a viable long-term alternative to liberal capitalism, but there is no reason for the governments that use it to ditch it this year. 

Why not? Look again at China. The vast majority of its state-owned enterprises and privately owned national champions lag far behind multinational corporations in access to state-of-the-art technology, branding expertise, and market share. They still have work to do and can use every advantage their government can provide to narrow the gap with their foreign competition. In addition, China remains a hugely important market for foreign companies and investors. This provides Beijing with the leverage needed to help more Chinese companies find their footing.

In other words, China has not exhausted its opportunities to "level the commercial playing field" (from China's point of view) or "further stack the deck" (from everyone else's). 

One day, the changing competitive landscape in China will make that market much less attractive for outsiders, and things will have to change. A rising standard of living will make China's plentiful labor and capital much more expensive, encouraging companies to look elsewhere in Asia for these advantages. This process is already underway, and even some Chinese companies are joining their foreign competitors in opening up shop in places like Vietnam, Thailand, Indonesia, Malaysia, and the Philippines.

In the end, the Chinese government will have to liberalize its economy. It won't be easy, because all these state-owned companies will have their defenders within the political elite and the bureaucracy. But for the time being, it is clearly in China's interest to stay the course awhile longer.

Not that China's leaders care very much what we think.

Ian Bremmer is president of Eurasia Group and author of End of the Free Market: Who Wins the War Between States and Corporations?