State Capitalism and Western Society (Part Three)

What Lies Ahead for China and Western Capitalism?

State-Capitalism

The Chinese economic success has been beyond what the most optimistic projections originally foresaw.

How to reconcile the traditional Western capitalistic economic model with the Chinese version?

There are three fundamental points to consider:

  • First, and foremost, the essence of the great success of the Chinese economic model resides in a massive —albeit in a highly controlled way— conversion to capitalism, as stated in the 5 points pinpointed in last week’s Part Two of this series. Although with many imperfections, the Chinese capitalist version has so far clearly prevailed over the not small number of internal structural obstacles standing in the way; otherwise, that success simply would not have materialized.

  • More often than not, state-owned enterprises (SOEs), if anything, are a hindrance but a necessary evil in any economic system. The reason behind it is quite simple: most of the time, SOEs operate with frequent —most of them permanent— impediments and/or costly distortions of the free-market capitalistic system. Both, the explicit and opportunity costs those distortions generate tend to be extremely onerous. China’s case is no exception.

  • SOEs are not exclusive of Communist or former Communist nations. There isn’t a single country on earth that does not have them. Nonetheless, experience shows that, with very few exceptions, SOEs are a liability and not a valuable resource. Albeit to a substantially lesser degree, SOEs are also relatively common in Western society. According to the OECD’s website, at the end of 2012 its 34 member nations had 2,111 fully or majority-owned SOEs, with 5.9 million employees, and a combined value estimated at US$2.2 trillion. As The Economist (January 11th 2014) very aptly pointed out, this is roughly the size of the global hedge-fund industry. Thus, by no means is China alone in this gigantic opportunity, although given relative sizes, China has much more room to grow and to benefit from than the rest of the SOE world, probably even in absolute terms.

The bottom line is: Adam’s Smith’s “invisible hand” concept is virtually impossible to apply in traditionally managed state-owned companies.

The SOEs that are appropriately managed, like Norway’s Statoil [STO], and Colombia’s Ecopetrol [EC], owe a lot of their good management to the savvy application of some basic concepts and practices of private enterprise, like having outside independent directors on their boards, listing the companies in the stock exchange —thus having private stockholders too, coupled with all the mandatory transparency, like publishing quarterly reports, and by applying a strict adherence to the basic principles of good management and good governance, according to the  best international practices.

Being in unexplored territory, nobody knows for sure what —and for how long— comes next in the Chinese economic system development. One thing is for sure, though: The most prosperous China gets, the more it will have to abide by the rules of the capitalistic system, as practiced in the developed world. Of utmost importance, history unequivocally shows that the best fit for a capitalistic economy is its inherent freedom, in all possible orders, including the political one. So, the longer it takes for China to transition into a more transparent system, the more difficult it will become for it to sustain high economic growth rates during the coming years, substantially higher than the developed world, thus eventually being forced by circumstances to develop one of these two mutually exclusive possibilities:

  1. Relative stagnation —in regard to the developed world’s performance— by eventually growing at similar rates than the average of the developed world —way before becoming a developed nation— thereby putting an abrupt end to the economic miracle, or

  1. Also emulate Western political institutions and practices, or some improved version of them, providing China the possibility of continuing its economic miracle. As the old saying goes, “It is not possible to have it both ways”.

Order, discipline, and intelligent hard work are indispensable ingredients for success in anything, including a thriving economy. Where the Western economic system seems to excel with no parallel in sight is with two additional key ingredients impossible to comply with by authoritarian governments: freedom and motivation.

So far, China has been able to cruise ahead at a substantially superior growth rate than the developed world, thereby effectively closing the —still gigantic— gap that separates them at a formidable pace. That feat can be considered “the easy part”, the first stage, which already seems starting to stay behind. From the present stage onwards, challenges are tougher, and therefore, more difficult to overcome, unless freedom and motivation start to appear on the Chinese scene on an ever more frequent and adequate dose.

The flourishing middle class with abundant professionals and yuppies that the economic boom has created is a force that should not be underestimated by the Chinese leadership. This segment of society is permanently connected to the outside world; many of the people in that group has lived abroad while attending a foreign university and/or working for multinationals, more often than not maintaining a close and permanent business interaction with colleagues and company representatives from nations in the outside developed world. This population segment is fully aware about how Western society functions and has a strong desire for a genuine openness and standardization of the Chinese political system, yearning for the type of freedoms and quality of life Western civilization takes for granted.

The Chinese society has already enjoyed, and gotten used to experiencing socio-economic upward mobility. In most likelihood, a growing portion of the Chinese population won’t settle for less. History shows that once the benefits of capitalism have been experienced by a sizeable part of the population, it’s is virtually impossible to reverse the process —the “toothpaste syndrome”; once the paste is out of the tube, it is impossible to push it back in.

State capitalism is not necessarily inherently bad. There are interesting and commendable exceptions, like Norway’s Statoil, Colombia’s Ecopetrol, and Canada’s public healthcare and education system, to name four of the not so many praisable cases around. Nonetheless, for every laudable case there are tens, if not hundreds, of deplorable instances spread around many developing nations —like Brazil and Mexico, just to name a couple of highly visible countries—, and even not that infrequently in developed nations. This assertion is virtually uncontroversial, given the overwhelming statistical and financial evidence in that direction.

I strongly feel that, as long as authoritarian governments remain as such, the West should not be either surprised or particularly afraid of the astounding initial success that state capitalism can generate, as has been the Chinese case.

Either authoritarian governments convert to a similar —or improved— version of Western capitalism, or the initial astounding success will eventually taper off, unless the nation in question truly begins to offer its citizens growing doses of freedom to keep motivation and productivity high, aspiring to outperform the best run governments in the world, for the benefit of their population.

Authoritarianism tends to reward conformism, setting a very onerous ceiling on imagination and creativity. The Western political system does not have that humongous structural limitation embedded in it.

In the fourth and final part of this series……Does China Have What it Takes to Continue its Growth Spurt?

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About Martin Marmolejo

Global Investment Manager | Founder & Managing Director at MMA Global Investment Management | Proud husband and father | Follow me @globalmarmolejo.

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