Shaking Hands

The peculiar high five of the invisible hand of the markets and the visible hand of the government has been shaping a new form of capitalism: state capitalism (SC). After reading the January 21^st – 27^th The Economist edition’s great special report on state-capitalism (a must-read) I’ve been wondering about the sustainability of this model. Using some pillars of the free-market capitalism (FMC – I’ll use freely expressions like free market and liberal for the same sort of capitalism, without worrying about conceptual differences that may exist), the state capitalists countries’ companies compete with the developed nation’s rivals under the government’s protection (i.e. subsidies, cash infusion, credit supply, “benevolent” legal environment, exchange rate manipulations, etc.).

Of course some attempts made by the state are equivocate and the fact that in SC the government points the finger for those who will be succeeded (letting open here the meaning of success) may give some space for distrust. From my point of view, in order to make that new form of capitalism live as long as it can, it is fundamental that the policymakers understand/assume that the “selected” companies should be such that i) the govern is boosting its country’s comparative advantages and let other sectors/segments free to compete and ii) it’s a business that the state has a minimum level of competence.

One example of comparative advantages is due to endowment differences. Take China for instance. It is a labor-intensive country with low (though rising) real wage and has an export-oriented growth strategy. Adding an artificially undervalued (real) exchange rate improves its situation and becomes hard to compete with. On the other hand, it’s not a leading-in-innovation country, so maybe investing in a copy of the Silicon Valley wouldn't be a good strategy (using state-owned companies).

It’s well known that state-owned companies are less productive and they are better in infrastructure than consumer goods and innovation as the foresaid report points out. But there are other problems. Corruption is, as far as I can see, the greatest tumor. As brilliantly mentioned in the report, the SC model arises from countries with problematic states. There’s a huge room for corruption in a system that is responsible for regulating itself and in a country where it’s institutional architecture is not very solid.

The report quotes the idea that the like the socialism, the state capitalism cannot survive only in one country. I will go further. It depends also on liberal capitalism in other countries. Think about it. One great advantage of state capitalism is the use of the capitalist toolkit backed up by the government’s safety net when copying the freer capitalist’s ideas and implementing them with its own competition model. But without FMC, who’s going to innovate? What would be the non-state-backed-up enterprises that would consolidate the state support as an advantage? This could worsen the whole innovation process in the limit, given the fact that it’s not the strength of SC countries to manage the innovation. (One could argue that they could learn, well, I’ll let this open without worrying about this particular point).

After a few considerations regarding benefits and issues of the SC (for a really comprehensive text go to the report), the situation as I see it is one where the new model will impose some difficulties to the FMC, but not in a way that only one should remain at last. It may be more in a sense that the reign of the developed countries are now challenged in the next years by a model that shares the weapons, but boosts them differently (and also has other sort of weaknesses). I’m not sure that is a system for remaining after some development threshold. There could be a point where this model may have to open space for another one (a sort of a macro creative destruction), and the country must prepare itself before reach this threshold. Some economists are already arguing that China should change its growth model from export-oriented with government investment playing a huge role, to a more domestic consumption-focused approach. If this is true, what would be the implications on SC? I personally don’t know. (One may remember that Brazil is a relative closed economy and has its own SC model; well, it’s a different SC than the one adopted in China as far as I can see).

P.S.: I want to make a remark about the role of the state and what I have been defending about other topics such as the crisis’ response. I’m very inclined to the Keynesian approach and I've been using its tools (specially the static IS-LM and AS-AD framework) for illustrating as simple as I can what I think. This has nothing about my concerns about the SC. Briefly, (New?)Keynesian economics is, in my opinion, a) recognizing not only the importance of the monetary policy in affecting business cycles, but also that the fiscal policy can impact the output in the short-run, and sometimes is all the policymakers really got (e.g. within a liquidity trap); b) that imperfections, asymmetries, rigidities and other deviations from perfect competition are real things and sometimes public policy (taxation, regulation, and so on) is necessary for minimizing distortions (even though they may also be the cause); c) the importance not only of the expectations, but the animal spirits in the people’s behavior as well, i.e. being aware that some schizophrenic outcomes may happen and multiple equilibria may be a real issue. (Yes, there are several more points about Keynesian economics; I just want to highlight the difference of fiscal stimulus and state participation in other layers of the economy).