Ian Bremmer

This piece originally appeared in Reuters Magazine.

As Europe’s leaders struggle to restore confidence in the single currency and America’s economy limps ahead at a painfully slow pace, China’s economy continues to power forward at its now characteristically strong clip. For the past three decades, China has been the world’s fastest growing economy—and within the next several years, the People’s Republic will overtake the United States as the world’s largest. Some economists have even argued that, measured by purchasing-power parity, China has already pulled ahead. Such prognostications, accurate or not, have led to dire warnings that liberal capitalism’s best days are behind it, that the future lies with authoritarian market managers who are able to relocate populations and move mountains by decree. For the moment, at least, state-managed capitalism appears to be triumphant.

Such appearances, however, are misleading. The appeal of state capitalism lies in its ability to withstand the occasional crises that afflict market systems, thus shielding the general population from politically inconvenient disruptions. It is a system in which the state uses state-owned enterprises, national champion firms, sovereign wealth funds, and politically loyal banks to dominate the process of domestic wealth creation. To be sure, this is not communism; significant segments of state capitalist economies are in private hands. But the state plays the largest role in ensuring that market forces serve political ends—by ensuring that, profitable or not, businesses invest in projects that bolster social stability and protect the ruling elite’s political control.

China is not the only state capitalist economy producing impressive results. As the Arab world continues to contend with the risks of political turmoil, Saudi Arabia and the United Arab Emirates have stockpiled the cash they need to maintain stability by controlling much of the wealth produced by national oil companies. Even some emerging democracies have begun to flirt with limited forms of managed capitalism. Brazil’s private sector remains crucial for the country’s expansion, but its government leans on state-owned energy firm Petrobras and privately owned mining champion Vale to help create jobs. President Dilma Rousseff’s government won’t milk cash from these firms as President Hugo Chávez has done with state-owned oil company PDVSA in Venezuela, but Petrobras is already at risk of becoming a much larger, less efficient, and thus less profitable company.

State control is not the future of capitalism. It is a dead end from which China will have to free itself if it is truly destined to dominate the world economy. As a system and by design, state capitalism ensures that wealth creation does not threaten the leadership’s hold on political power. Its ability to stimulate growth and general prosperity is a secondary benefit. Forced to choose between public wealth and political survival, state capitalists will always protect their own interests first. In China, as elsewhere, commercial activity depends on access to information, and the Internet provides the best and most efficient access to it. Yet if the Internet threatens to enable popular resistance to China’s authoritarian government, and if political officials have the means to shut the Internet down, even temporarily, they will do just that.

State capitalism’s greatest weakness lies in its intolerance of “creative destruction,” a process that invests liberal capitalism with vital self-regenerating momentum. The liberal capitalist model makes it possible for the workers, resources, and ideas invested in a dying industry to spontaneously recombine in novel configurations to produce goods and services that satisfy emerging demand. But the economic engineers of state capitalism fear any form of destruction that develops beyond their control. This is why state-owned companies, which build influence within government over time, often succeed in resisting the need to adapt to changing times.

Then there is the question of openness. Within autocratic state capitalist systems, government-owned companies like China National Petroleum Corporation and some of the Arab world’s sovereign wealth funds shun the transparency that long-term resilience and adaptability demand. This opacity can benefit a country’s ruling elite by hiding unsuccessful investment decisions, but it is very harmful for the system’s long-term health. When such institutions can hide their failures, they are free to inflict much more lasting harm than they otherwise could.

Managed capitalism also falls short when it comes to exploiting innovation, though government-directed investment can play an important role in the development of new technologies. The Internet arose from a U.S. government subsidized defense project, but it was profit-driven companies that developed and reimagined the Internet and thus transformed the world. History shows that over time state officials never value assets and allocate resources as efficiently as market forces can.

Even in China, state officials understand that citizens are the engine of economic vitality. That is why the state has embarked on an historic and ambitious plan to shift wealth from China’s largest companies to the country’s consumers. China’s leaders know that the next generation of economic growth must be less dependent on exports to Europeans and Americans; creating domestic consumer demand is crucial. Thus the process of empowering Chinese consumers will undermine state capitalism’s appeal even within the country that has made this system so seductive.

By Ian Bremmer
The views expressed are his own.

One of the biggest changes we’ve seen in the world since the 2008 financial crisis can be summed up in one sentence: Security is no longer the primary driver of geopolitical developments; economics is. Think about this in terms of the United States and its shifting place as the superpower of the world. Since World War II, the U.S.’s highly developed Department of Defense has ensured the security of the country and indeed, much of the free world. The private sector was, well, the private sector. In a free market economy, companies manage their own affairs, perhaps with government regulation, but not with government direction. More than sixty years on, perhaps that’s why our military is the most technologically advanced in the world while our domestic economy fails to create enough jobs and opportunities for the U.S. population.

Contrast the U.S. and its free market economy with China’s system.  For years now, that country has experienced double digit growth. Many observers would say that China’s embrace of capitalism since 1978, and especially since joining the World Trade Organization in 2001, has been responsible for its boom. They would be mostly wrong. In fact, a new study prepared for the U.S. government says it’s not capitalism that’s powering China, but state capitalism — China’s massive, centrally directed industrial policy, where the government positions huge amounts of capital and labor in economic sectors it intends to nurture. The study, prepared by consultants Capital Trade for the U.S.-China Economic and Security Review Commission, reads in part:

In a world in which central planning has been so utterly discredited, it would be natural to conclude that the Chinese government and, by extension, the Chinese Communist Party have been abandoning the institutions associated with the communist economic system, such as reliance on state‐owned enterprises (SOEs), as fast as possible. Such conclusion would be wrong.

In a G-zero world where no country can claim the mantle of international leadership, China has pulled an accomplished head fake. While the media focuses on China’s special economic zones, like Hong Kong and Macau, and the rise of the banker class and Chinese tech industry, state directed spending is the real engine of growth.  Capital invested in infrastructure like factories, heavy industry, roadways, and high speed trains continues to power annual double digit growth in GDP. Reliable data from 2004 shows that 76% of Chinese non-financial firms are classified as State Owned Enterprises (firms with government ownership of greater than 10%).

In short, while the U.S. has spent decades and vast treasure building up its defense system (and yes, by extension, the sectors of the economy that service it), China has spent its time and money building up control over the broad direction of its entire economy. In today’s world, where the first sentence of this essay rings true, which country currently looks better positioned to, pardon the pun, capitalize, in the years ahead?

During last week’s euro zone bailout talks, French President Nicolas Sarkozy went hat in hand to China, painting a stark picture of China’s still-growing economic importance internationally. Never mind that the phone call didn’t result in any particular action; the mere act raised Chinese President Hu’s profile going into the G-20 talks in France this week. Not only that, the entreaty by Sarkozy made plain that China has nothing to hide about the economic path it’s chosen for itself. After decades of hectoring from the West, the tables are perhaps about to turn. After all, what economic model should China emulate? Europe’s? The United States’? “With all due respect,” you can almost hear President Hu saying, “we like the way our system is working, thanks.”

There is, though, a fatal flaw with state capitalism. It works, and it will continue to work, until the day that it doesn’t. China’s economic growth is built on the back of cheap labor. As China’s wealth and per capita GDP (currently $4,400 compared to the U.S.’s $47,000) continues to rise, that labor will one day cease to be cheap — perhaps not compared to the U.S.’s, but certainly compared to the labor forces in India, Turkey and across Southeast Asia.  This trend is already beginning, as we have seen multinational companies turn to countries like Indonesia, Vietnam, and Thailand for cheaper labor in the region.

State capitalism requires that the state have access to a cheap good or service that has high value in trade. Saudi Arabia has oil, Argentina has mines. Reaching back further, as New Yorker writer John Cassidy has recently noted, the British had access to cheap Indian opium that 19th century China snapped right up. When China’s emperor protested the drugging of his people, the British sent warships to force its ports open. State capitalism, in other words, has a long history as midwife to economic powerhouses. China’s cheap resource continues to be its labor. The leadership there is going to protect that resource as long as it can, through any lever its government can control.   When state capitalism breaks down, the results will be ugly if the government has not adequately braced the economy for fundamental change.

At the heart of every military conflict, after all, is some sort of trade war. It’s not a bad thing that the U.S. has invested so much in its own security. But in a world where economics drives geopolitics, the U.S. will be in a decades-long race with China to maintain its perch as the world’s largest economy, and it will have to do so with a much smaller population and relatively anemic growth, compared to China’s rapidly urbanizing population and its double-digit annual GDP bonanzas.  That assumes, of course, that China weathers the shocks that state capitalism will bring, and manages to overcome a looming demographic problem as the population ages without an adequate social safety net in place.

Make no mistake — China’s leaders are well aware of the economic power they currently hold, but they also recognize the potential for more prosperity and influence if they can carefully manage their economy for future generations — and the consequences should they fail. It’s good — and long overdue — that the U.S. learns more about their system, and Capital Trade’s important new study is a step in the right direction.

This essay is based on a transcribed interview with Bremmer.

Photo: China’s President Hu Jintao (L) and France’s President Nicolas Sarkozy (R) discuss  before the start of the G20 Summit of major world economies in Cannes November 3, 2011. REUTERS/Charles Platiau