Why State Capitalism Is Beating The Free Market

And why New Zealand is no good at either…

by Gordon Campbell

Lead image Lyndon Hood

Late last month, the Economist magazine published a debate on state capitalism, in which it proposed that state-led market economies are fast becoming a global rival to the old models of liberal, free market capitalism. The chapter and verse it provided is indeed pretty impressive. More than three-quarters of the world’s oil reserves, the magazine reported, are controlled by state-backed companies, ranging from the world’s biggest natural-gas company, Russia’s Gazprom to Brazil’s Petrobras. Saudi Basic Industries Corporation is the world’s second largest diversified chemicals company, Russia’s Sberbank is Europe’s third-largest bank by market capitalisation. Dubai Ports happens to be the world’s third-largest ports operator, and Emirates is one of the world’s fastest growing airlines.

Reportedly, state companies comprise 80% of the value of the stockmarket in China, 62% in Russia and 38% in Brazil. Together, the Economist summarised, they accounted for “one-third of the emerging world’s foreign direct investment between 2003 and 2010 and an even higher proportion of its most spectacular acquisitions, as well as a growing proportion of the very largest firms: three Chinese state-owned companies rank among the world’s ten biggest companies by revenue, against only two European ones.”

All of which suggests that long ago, the real world made up its own mind about whether government belongs in business. The trend seems very relevant to New Zealand, given our history of dependence on the state for building social and physical infrastructure, fostering innovation and investing in research and development – and our habit of living in denial about this discomfiting reality. Yet as the financial analyst Brian Gaynor points out by way of illustration, the current share market is full of companies like Solid Energy, Air New Zealand, Telecom etc that owed their origins to the state. Paradoxically though, our political rhetoric since the mid 1980s has been dominated by liberal exhortations to cut regulatory red tape, lower taxes, reduce labour protections, privatise assets and thus release the entrepreneurial spirit alleged to exist within our private sector. For all the free market noise, little in the way of sustainable growth has eventuated.

In other words, economic reality in New Zealand tends to differ from the political rhetoric that is routinely in play. If it is to succeed, the mixed model economy depends on a active, state-led partnership between government and business, in which government does a lot more than simply try to get out of the way. Yet there have been few signs of the inclination – let alone the ability – to foster and manage the collective forms of capitalist endeavour that are increasingly the global norm – especially within those emerging countries that like, New Zealand, have been trying to graduate from dependence on agricultural based exports. Last week for instance, the Washington Post described the new reality in these terms:

…Innovation is increasingly coming from groups, not solitary heroes. Capitalism as a communal enterprise — dare we call it collective capitalism? — is the new engine of innovation, in America and beyond, but it doesn’t seem to square with our culture.

Yet, theories about solitude and creativity notwithstanding, the basic innovative grunt work is now more likely to be done not by a lone wolf but by a wolf pack; there is simply too much information and too much complexity for it to be otherwise…. Already we are seeing how this new innovative collaboration works: in the browser Firefox, which is a product of a community of thousands of programmers; in the Netflix algorithm, which is a result of teams of researchers working together;…

This new reality doesn’t draw on the American entrepreneurial myth of singular achievement. It is based instead on something deeper — our roots as social beings who desire collaboration. We may like to continue thinking that…..individualism has shaped and will forever shape the modern world, but here is where cultural self-perceptions and economics can clash. We have got to overcome our hyperactive sense of exceptionalism and embrace the more collective, cooperative and globalized forces shaping the planet

There is no sign of that collaborative approach in Treasury’s recent briefing paper, which repeats (sigh) the old neo-liberal policy menu of (a) shrinking the state (b) lowering taxes on capital and (c) shifting costs onto the captive consumer, or in the case of education consumers, onto the child in the classroom – where the “savings” from bigger class sizes would be used to fund performance-based incentives to those teachers who can cope with the related classroom pressures. This approach has been tried in New Zealand for decades, and has failed to achieve sustainable economic growth, while creating one of the fastest growing rates of income inequality (and with it, the diseases of poverty) in the entire OECD. It has also failed to make any inroads into New Zealand’s chronic dependence on agricultural exports. Collaboration by contrast, means including workers and consumers in the policy mix, and not treating them as obstacles, or as cash cows.

In that sense, the recurring criticism that the Key government has no economic plan seems somewhat beside the point. The plan being followed by government merely reflects the indecision that exists amid the corporate sector that it seeks to serve. More of the same though, is bound to fail. For the past 25 years, almost everything business has asked for has been given to it – lower tax rates for business and high income earners, less restrictive labour practices, greater freedom from environmental regulation…and yet, sustainable economic growth remains a mirage. To outsiders, it would come as no surprise that given a small country of four million situated far from global markets and with relatively few natural advantages, a decision to promote policies that involve government abdicating its leadership role would turn out to have been self-defeating. Worse, many of the tools and processes of economic activity that have proven successful in state-led economies elsewhere – in Germany, Brazil, Scandinavia – have been sold, or abandoned.

We may now be in the terminal phase. One of 2012’s main political stories for instance, will continue to be the partial sale of state assets. Bathetically, this marks an attempt by government to invigorate the New Zealand sharemarket, in an economy which has shown itself incapable of producing a sufficient influx of healthy firms able to attract investors on their own merits, without assistance from the state. Again, the reduction of state ownership is based on the wrong-headed premise that this will enhance efficiency and productivity – when there is no empirical evidence that the state companies in question have anything whatsoever to learn from the private sector.

So far, critics of the state asset selldowns have focussed on the spectre of eventual foreign ownership of the shares, but the more pressing concern is the extent to which private speculators ( whether home- grown or foreign) will seek to recoup their investment by raising energy prices. This would require the collusion of the state. Under a mixed model system of modern state capitalism, the real issue may not be ownership so much as pricing – and whether the state sees its main role as being (a) to protect the citizenry from price gouging, or (b) to assist private capital to maximise its returns, regardless of the social cost. On past performance (b) is likely to be a clear winner.

Should New Zealand actively embrace the state capitalist model, given the failure of the neo-liberal alternative? First, some definitional issues. In the process of going to bat for old school liberal capitalism in the Economist, political scientist Ian Bremmer defined state capitalism as being a system in which the political elites control the vast bulk of economic activity, for their own political and personal gain. To Bremmer, the most typical examples of state capitalism tend to be oligarchies —China obviously, but also Russia and various Arab countries. Not surprisingly as the moderator of the Economist pointed out, Bremmer’s criticisms of state capitalism flow directly from his definition :

Given that the primary purpose of state capitalism is to keep oligarchs in power, the system will inevitably fail at producing wealth, at least in the long run. State capitalists cannot tolerate the two things that make for dynamic economies: the free flow of information that empowers entrepreneurs and consumers and the creative destruction that allows vigorous new firms to replace tired old ones.

According to this view, the current flaws of liberal capitalism are not terminal problems : “Liberal capitalism has survived huge challenges in the past. It will do so again.” Unless of course, it doesn’t – and the problems evident in parts of Europe prove to be beyond the powers of the market or its corporate chieftains to self diagnose, and cure. In which case, there is room for a much broader definition of state capitalism, as advocated by economist Aldo Musacchio of Harvard Business School. Such a system – which will sound familiar to New Zealanders – is one where governments, whether democratic or autocratic, “exercise a widespread influence on the economy, through either direct ownership or various subsidies.” In successful emerging economies such as Brazil, the state has chosen to take a leading role in picking those sectors and companies likely to prosper –with the state oil company Petrobras being a prime example – and will then support them to the hilt in whatever ways it can. As the Economist’s points out:

This hybrid form of capitalism—state support disciplined by the market—gives state capitalism three huge advantages, according to Musacchio. It produces global champions that have quickly risen up the ranks of the world’s top companies. It gives companies the freedom to invest for the long-term rather than obsessing about short-term profits. And it smooths the economic cycle: state-capitalist countries such as China were much faster to cope with the consequences of the financial crisis than liberal-capitalist countries.

So where does that leave New Zealand on the spectrum – given that as business commentator Rod Oram has argued, our agriculture commodity economy is peculiarly vulnerable to the swings of the economic cycle, both domestic and global. Superficially, it could be said that New Zealand has always had a state capitalist system (in both senses outlined above) run largely for the benefit of its political and corporate elites, which merely changed their membership during the 1980s – as those elites that had profited from protectionism were replaced by the elites that profited from financial de-regulation.

At the same time, in adopting the political rhetoric and much of the practice of liberal free market capitalism, New Zealand also went through substantive change in the scope and role of government. Vital infrastructure (in telecommunciations, transport, banking and soon, energy companies) was either sold outright, or had the state’s role significantly reduced. At the same time, New Zealand has atomised its work force in ways avoided by other, more successful state capitalist economies – ie Germany, Australia, Brazil – which tend, as the Economist also pointed out, to use the disciplines of the market to strengthen their national champions, rather than promote policies that merely protect them from global competition. (Old school protectionism isn’t a hallmark of state capitalism, at least not anymore. )

New Zealand has now largely divested itself of the ability to do likewise. If anything, it has simply exposed its private sector to global competition and hoped for the best. For the past 25 years successive New Zealand governments have tried to make a virtue out of selling its existing or potential champions, and encouraged work practices (casualisation, contracting out) geared to short-term profit taking, rather than to long term performance and viability. The focus has been on reducing the cost of labour, rather than seeking ways to utilise organised labour to national advantage. The current attack by Ports of Auckland management on the work conditions on the Auckland waterfront – which is occurring despite productivity at Auckland already being higher than in comparable Australian ports, and where Auckland’s health and safety record is better than exists in Tauranga, the model being advocated. Similar short-sightedness ( and abdication of the duty of care) exists in environmental policy, where government appears intent on defeating its own target of 90 % renewable electricity generation by 2030. A hat tip is owed to No Right Turn for pointing out this contradictory segment of the Ministry of Economic Development’s briefing paper to its new Minister, a classic of the “government getting out of the way” genre:

The Ministry’s view is that commercial enterprises are best placed to identify the lowest cost generation mix, the government’s role is to ensure there are no undue barriers to invest in generation of any type, and environmental effects are priced wherever possible. The relative economics of generation types is dictated by exchange rates (a higher exchange rate favours high capital cost options such as wind), emissions price (a high emission price favours renewables) and input resource availability and price (the availability and price of gas has a major bearing on gas plant economics).

Unfortunately As No Right Turn also points out, the latest New Zealand Energy Outlook shows the market likely to achieve only 81% renewables by 2030, thanks to new builds of gas, oil, and even coal generation.

A competent Ministry would highlight this discrepancy, and present options for resolving it. A government which cared about the target would demand they did so. Instead, MED’s “leave it to the market” approach puts us on the path to failure. But its worse than that – because while they’re ignoring renewables, MED is also talking up new non-renewable generation.

For now though, the state energy company selldowns – and the campaign to casualise the work force by the Ports of Auckland – remain the most telling examples of government bailing out on its managerial role in the economy – even when it is the only significant player able to serve the national interest, and even if it means foregoing significant amounts of revenue. Given their recent healthy annual returns, the four energy companies now being put on the auction block have little to gain from further exposure to the disciplines of the market given that – under full state ownership – they are already exceeding the performance of the private sector. Similarly Air New Zealand, while almost entirely in state hands, has survived the global recession in surprisingly good shape under its current ownership structure.

New Zealand has an identity problem, in other words. We are state capitalists who have been trying – for the last 25 years – to be funky liberal capitalists, a process that has all but eviscerated our ability to be successful in either role. Thankfully, some building blocks of this approach are now being re-thought. Not in Treasury, which seems determined to go down with the neo-liberal ship, even if that means taking the country down with it. But a more pragmatic and activist role for government is being argued by the likes of financial columnist Bernard Hickey:

The surge in our currency this week to a five-month high against the United States dollar and a record high against the euro highlights how we are losing in a race to the bottom. Britain, Europe and the United States are determined to print more money to devalue their currencies to protect their own economies….

This Northern Hemisphere strategy of print and hope is fine and understandable for them. Their export sectors become more competitive and they can preserve or create jobs in exporting and import substitution. But it is in effect a beggar-thy-neighbour strategy in which investors can borrow at near zero per cent interest then buy assets in higher interest rate currencies to make an easy profit. It is fuelling a surge in cash around the globe on a hunt for hard assets such as farmland, mines and oilfields….

New Zealand’s manufacturing exporters should now be very worried. The print-and-hope strategies look set to leave anyone who doesn’t follow suit sprawling in the dust. We saw the inevitable results of that with yet another collapse of a manufacturing exporter this week. Auckland’s Criterion Furniture called in the receivers after a decline in exports into these markets. There are now 180 workers wondering if they will keep their jobs.

They are the ones left standing. How long before New Zealand has to join the game? And can we afford to stand by and just let it happen to us? Our Government seems comfortable as a spectator. At some point it may have to become a player.

Right. That’s if the Key government (a) had the inclination, and (b) the ability. Theoretically, the recent resignation of Reserve Bank governor Alan Bollard – due to take effect later this year – might also have been an opportunity for a re-think. Unfortunately, as Brian Gaynor has indicated, the need for the RB to have a wider regulatory role may be there but the personnel don’t appear to be:

A recent research paper by the Brookings Institution – Rethinking Central Banking – recommends changes to central bank mandates. The paper argues that the recent property and financial bubbles, followed by the Global Financial Crisis, have shown that central banks need wider objectives. The institution believes that central banks should be able to implement policies to counteract rapid credit growth, asset price bubbles and other financial excess even if it means that inflation targets are missed.

If the Reserve Bank had a financial stability objective then it could have taken action to control the finance company sector excesses but it had no mandate to do so. This issue is particularly important because the main candidates to replace Bollard are “economic dries”. These are individuals who generally believe that the Government and its agencies should play a minimal role in the economy.

The “dries” believe that markets automatically self-correct before excesses develop, although recent worldwide developments contradict this widely held belief. A good example of a “dry” is former US Federal Reserve chairman Alan Greenspan who continues to believe in the power of the market and advocates minimal government and central bank intervention.

….The next Reserve Bank governor needs to have a wider mandate, as recommended by the Brookings Institution, because it is unlikely that any of Bollard’s obvious replacements will be willing to embrace a wider role unless specifically required to do so.

To be successful, state capitalism needs intelligent activists in government. There are countries, Gaynor told me for this article, that believe in the positive role that governments can play, and those that don’t. “And we of course, are the latter. Its very hard to go from one to the other, because the thinking has become so entrenched…Sorry if this is a bit off the point, but I see New Zealand as an agricultural-based economy that has been unable to make the transfer to a more diversified economy. That’s why we have these big debates over the sales of farms because farming dominates the economy here, probably more so than in any other Western country…”

Roger Douglas, Gaynor continues, tried to end the government’s domination of the non-agricultural sectors of the economy “ But he didn’t come up with any replacement. He just said the market will deliver a replacement. And the market hasn’t delivered a replacement.“ But since the government is the only significant domestic source of risk capital, won’t any escape from New Zealand’s current situation need to be state-led? “Yes, Gaynor replies, “ but there would be huge opposition to it.”

Most people in New Zealand, he continues, are “incredibly reticent” about anything these days that smacks of risk. “Therefore, if the government started doing something different, it would more than likely be subjected to severe criticism from the electorate…For any government to sponsor innovation or to be a seed capitalist or whatever, is going to be very, very difficult in New Zealand. Because the mood at the moment – and this can change of course over time – is unbelievably negative towards that kind of thing.” Much of the resistance to the state asset selldown, he points out, is motivated by a conservative impulse to retain what we have. “At the same time, they don’t want to fund anything that is new and developing. It’s a funny mixture that we have here…”

Personally, Gaynor did think 10, 15, or 20 years ago that politicians could play a major role in the necessary transition but now…easy answers strike him as being in short supply. For now, the Key government’s plans appear to begin and end with the book-keeping task of trying to generate a surplus by 2014/15, which it is achieving (in large part) by cutting back on spending, services and jobs in the state sector. This goal seems to be an end in itself. Getting there will involve significant reductions in the state’s scope, revenue and ability to deliver services.

Not that there is any clarity about the road intended. When announcing his Cabinet late last year for instance, Key signalled that job creation would be at the very top of his government’s second term economic agenda, and Economic Development Minister Steven Joyce was being vested with the powers to make it happen. Except….a month later in his Economic Priorities speech to the Waitakere Business Club, jobs and the potential role of business in helping to deliver them doesn’t rate a mention.

At the best of times, Key routinely fails to distinguish between what level of job creation is required merely to keep pace with the annual influx of new entrants into the work force – and that’s before any inroads can be made into the backlog of unemployment generated by the recession. Of course, this demographically-driven part of the employment picture is also affected by the rate of migration, and by the extent to which older workers remain in the work force, whether that’s by choice or through economic necessity.

Unfortunately, demographic trends may reward doing nothing. What we know from the five year Labour Force projections (that juggle varying levels of economic growth, migration, mortality and labour force participation) is that the influx of younger workers entrants will have peaked by in 2016 and subsided by 2021, before increasing again towards rhe end of that decade. Which means that government neglect of youth employment will get a demographic tail wind from around 2016 – and from even as early as 2011 onwards, given a scenario of medium rates of fertility and mortality, relatively low net migration, and depressed labour force participation. So if we do nothing – and economic activity continues to flatline – a dormant government will still be able to claim some success on youth employment, thanks to these kindlier demographic conditions.

That is depressing enough. But migration will also be a key player in the employment mix. Currently, some 495,000 New Zealanders are estimated to be living in Australia – ie, one tenth of the entire population of this country – and they comprise a large proportion of the total of 700,000 to one million Kiwis who live offshore.

For years, Australia has functioned as a social safety valve for our skilled workers and for those relatively unskilled New Zealanders ( many of whom are Maori) unable to find a job here at home. If as projected, the Australian economy slows down noticeably during 2012 – and China does likewise – the Gillard government is unlikely to be generous when it comes to offering welfare assistance to Kiwis left out of work. A lot therefore, will then be riding on the Christchurch recovery in 2013 to reduce the ranks of the unemployed here, as well as those likely to be winging their way home from across the Tasman, during the latter half of this year.

To conclude : the prevailing sense is of a government sitting on the sidelines like a spectator at Wimbledon – and watching the economic volleys and rallies pinging back and forth across the net, while living in hope that the game will (somehow) go into the fifth set before they have to pack up and leave.

One basic problem with free market prescriptions is that there is no counter factual. Failure is treated as success, or “creative destruction” whereby the “inefficient” go to the wall, only for others to rise phoenix like from the ashes. The upside of this process – which is destructive not only to firms but to communities, families and individual lives – is supposed to be innovation, as the competition for survival leaves only the fittest still standing. (In reality, creative destruction is just as often the result of the workings privilege and near-monopoly, rather than anything based on merit.) IN any case, there is little evidence that state-led capitalism is any worse than free market capitalism in fostering innovation. (Quite the contrary. Profit-driven science is more likely to be conservative, and driven by short term results.) As Harvard economist Aldo Musacchio pointed out during the Economist debate, modern state capitalist governments lead innovation – they do not stifle it :

Innovation requires risk capital, and governments usually tolerate more risk than individual investors do. Innovation in deep-sea drilling by Brazil’s national oil company, Petrobras, is one example of how a risk-tolerant, long-term investor can succeed. Petrobras invested for decades in research on deep-sea drilling, even though it was not clear there was any oil off the coast of Brazil. A private company would have given up looking and investing money in research when there was no sign of oil. By adopting foreign technology and developing its own technology in its own research centre, Petrobras found one of the largest offshore basins in 1974 (off the coast of Rio) and more recently off the coast of São Paulo. Scientists at Petrobras have won many times the Offshore Technology Conference award for innovation.

If innovation is the key driver of economic growth, then New Zealand ( for all its neo-liberal rhetoric) remains a prime example of a capitalism reliant on the state, and not on the private sector. The trouble is that there is not enough r&d spending from either source. Spending on r&d by the New Zealand government dwarfs the private sector r&d spend, and always has done – even if the rates of investment in both cases lag well behind the OECD averages.

All too typical. Routinely, our private sector has looked to government to do the heavy lifting on exchange rates, interest rates, corporate tax rates and the country’s labour laws. Rather than seeing labour as a partner in productivity – as in more successful economies – business has been empowered to treat labour as a disposable cost. This situation has given ordinary New Zealanders no faith in the country’s ability to manage public/private partnerships in future in ways that will prevent rorts – mainly because we have been given every reason to think that the strength of public investment will not be matched by regulatory discipline in how the contracts are written and enforced.

Regulation, finally, is the big part of the story. The regulatory failures that led to the recent global recession have discredited the free market model, and validated state capitalist alternatives. The lesson could hardly be more clear. If Gaynor is right and we cannot stomach a state-led capitalist recovery along Scandinavian lines, perhaps we could at least go part of the way, and endorse a situation whereby the courts, the Commerce Commission and the other regulatory agencies were given the power to police the market adequately. In essence, a trustworthy kind of “umpire state” may be the best we can hope for. One where the rules of the game exist not solely to facilitate profit-taking by business. Alas, a country where Bryce Lawrence and Billy Bowden are our most famous referees probably doesn’t inspire much confidence in our capacity to create a satisfactory umpire state, either.