Commentary

State Capitalism Versus Free Markets

How quickly the world can change. In 1989, communism collapsed across Eastern Europe. The Berlin Wall, the most visible symbol of communist totalitarianism, fell without a shot being fired.

People spoke of the end of history. The entire world would be democratic and capitalist. Even China seemed destined to join the Western camp.

In the fall of 2008, it was capitalism that appeared to stagger if not quite collapse. Much of the world moved away from free markets toward state capitalism if not socialism. Today, China offers that model as an alternative to capitalist America.

In The End of the Free Market, Ian Bremmer offers a realistic yet optimistic discussion of today’s competition between free markets and state capitalism. Although the total victory once envisioned for democratic capitalism looks far away, free markets will prove to be more flexible and resilient over the long term.

The collapse of communism was a moment of enormous human liberation. All of the formerly socialist societies looked west for answers.

However, liberty is good for individuals, not ruling regimes. Notes Mr. Bremmer: “Authoritarian governments everywhere have learned to compete internationally by embracing market-driven capitalism. But if they leave it entirely to market forces to decide winners and losers from economic growth, they risk enabling those who might use that wealth to challenge their political power.” This is one reason China consciously sought to avoid the Russian experience by maintaining political control even while liberalizing economically.

Democracy has made progress, but there is more to liberal society than occasional elections. As Mr. Bremmer explains, “there is plenty of gray area between Norway and North Korea.” Freedom House counts 121 democracies but a quarter of them are not free. The Economist Intelligence Unit cites 30 “full” democracies, 50 “flawed” democracies, and 87 “hybrid” democracies or “authoritarian” states.

Similarly, capitalism has advanced, though not as victoriously as once expected. The meme no longer is globalization sweeping all before it, effectively flattening the world’s once diverse landscape. Mr. Bremmer writes: “The power of the state is back. Over the past decade, a new class of companies has pushed its way onto the international stage: enterprises that are owned or closely aligned with their home governments.”

Of course, there is nothing new about either authoritarian government or state economic meddling. Mercantilism once dominated European politics. Although that philosophy has been discredited, “Governments are again intervening in their economies to promote declared national interests, and they have found subtler and more effective ways to practice protectionism,” notes Mr. Bremmer.

The tools of state capitalism are many. National energy companies are a favorite; nominally private concerns acting as “national champions” are another. Sovereign wealth funds have become a common means for states to invest wealth garnered from natural resource sales.

China and Russia are premier practitioners of state capitalism. Other examples include the United Arab Emirates, Ukraine, Algeria and Brazil. Even India, which has moved toward free markets while preserving democratic norms, “remains poised between the state-dominated economic model of an earlier era and one driven by private enterprise,” writes Mr. Bremmer.

The challenge to market-oriented democracies is obvious: Autocratic states have acquired resources and developed the means to employ them to political advantage. That gives them an opportunity to influence policy in Western nations and gain international influence at American expense. Indeed, state capitalism appears to enable dictators to gain the economic benefits of capitalism while avoiding the political perils of liberty.

However, state capitalism cannot avoid the inevitable inefficiencies of government control. There are good, even compelling reasons for financial liberalization and globalization. While the debate over the causes of the financial system continues to rage, it is obvious that government policy played a critical role. What could be a better example of a tool of state capitalism than government-sponsored enterprises such as Fannie Mae and Freddie Mac?

Moreover, self-interested politicians are unable to meddle just a little and in just the right ways. Thus, state capitalism will inevitably have negative consequences. As Mr. Bremmer explains, “Creative destruction ensures that industries that produce things no one wants will eventually collapse. When this happens in systems of state capitalism, the public blame falls on ruling elites, not evil capitalists.”

There’s more, however. One of Mr. Bremmer’s insights is that state capitalism lacks any positive appeal. It will, he observes, “never match the hold that communism once had on the popular imagination, because it isn’t really a response to social or economic injustice.” Indeed, the very purpose of state capitalism is to entrench ruling elites, not liberate oppressed masses.

Rather like fascism, state capitalism tends to be nationalistic. So international cooperation is difficult. Countries usually act against something (particularly the United States) rather than for something. Most of the countries practicing state capitalism also have domestic political challenges to deal with — it’s one of the reasons they have adopted this strategy. So domestic constraints will limit the reach of such systems.

The challenge posed by state capitalism is obviously real. But Mr. Bremmer believes real capitalism will win out. He writes: “Free markets will probably outlast state capitalism as it is now practiced in China, Russia, the Gulf states, and elsewhere — just as they bested Soviet-style communism.”

But it’s not enough to count on the system to work. The financial crash demonstrated how the supposed friends of capitalism often number among its greatest enemies. So he is right to call on “those who believe in free markets to learn from the failures that triggered a crisis, to practice the kind of capitalism they preach, and to renew their commitment to the principles that have helped them prosper.” Amen.

Doug Bandow, a senior fellow at the Cato Institute and a former special assistant to President Reagan, is the author of Foreign Follies: America’s New Global Empire (Xulon, 2006) and Perpetuating Poverty: The World Bank, the IMF and the Developing World (Cato Institute, 1993).