Argument

We're All State Capitalists Now

The debate about whether America or China will ultimately triumph is a red herring that distracts us from the real contest of our time.

If there is one issue on which the rival candidates for the U.S. presidency agree, it's that America's global leadership will endure. Mitt Romney insists it is not a "post-American century," while Barack Obama declared in his State of the Union address that "anyone who tells you otherwise, anyone who tells you that America is in decline or that our influence has waned, doesn't know what they're talking about."

They must enjoy this kind of chest-beating in Beijing.

That a resurgent China poses a challenge to American power -- especially in the Asia-Pacific region -- has been clear for some time to those who know what they're talking about. The real question is whether the United States has a credible response. Should it apply some version of the "containment theory" that the late George Kennan recommended for dealing with the Soviet challenge after 1945? Or something more subtle, like the "co-evolution" suggested by former Secretary of State Henry Kissinger?

Leave aside the military and diplomatic calculus and consider only the economic challenge China poses to the United States. This is not just a matter of scale, though it is no small matter that, according to the IMF, China's GDP will overtake that of the United States within four years on the basis of purchasing power parity. Nor is it only about the pace of China's growth, though any Asian exporter forced to choose between China and America would be inclined to choose the former; their trade with China is growing far more rapidly than trade with the United States.

No, according to some commentators, the contest between the two Asian superpowers is also fundamentally a contest between economic models: market capitalism vs. state capitalism. Speaking at the World Economic Forum in Davos this January, David Rubenstein of the Carlyle Group expressed a widely held view that the Chinese model of state capitalism is pulling ahead of the U.S. market model. "We've got to work through these problems," Rubenstein said. "If we don't do [so], in three or four years … the game will be over for the type of capitalism that many of us have lived through and thought was the best type." I think this view is dead wrong. But it's interesting to see why so many influential people now subscribe to it.

Market capitalism has certainly had a rough five years. Remember the Washington Consensus? That was the to-do list of 10 economic policies designed to Americanize emerging markets back in the 1990s. The U.S. government and international financial institutions urged countries to impose fiscal discipline and reduce or eliminate budget deficits, broaden the tax base and lower tax rates, allow the market to set interest and exchange rates, and liberalize trade and capital flows. When Asian economies were hit by the 1997-1998 financial crisis, American critics were quick to bemoan the defects of "crony capitalism" in the region, and they appeared to have economic history on their side.

Yet today, in the aftermath of the biggest U.S. financial crisis since the Great Depression, the world looks very different. Not only did the 2008-2009 meltdown of financial markets seem to expose the fundamental fragility of the capitalist system, but China's apparent ability to withstand the reverberations of Wall Street's implosion also suggested the possibility of a new "Beijing Consensus" based on central planning and state control of volatile market forces.

In his book The End of the Free Market, the Eurasia Group's Ian Bremmer argues that authoritarian governments all over the world have "invented something new: state capitalism":

In this system, governments use various kinds of state-owned companies to manage the exploitation of resources that they consider the state's crown jewels and to create and maintain large numbers of jobs. They use select privately owned companies to dominate certain economic sectors. They use so-called sovereign wealth funds to invest their extra cash in ways that maximize the state's profits. In all three cases, the state is using markets to create wealth that can be directed as political officials see fit. And in all three cases, the ultimate motive is not economic (maximizing growth) but political (maximizing the state's power and the leadership's chances of survival). This is a form of capitalism but one in which the state acts as the dominant economic player and uses markets primarily for political gain.

For Bremmer, state capitalism poses a grave "threat" not only to the free market model, but also to democracy in the developing world.

Although applicable to states all over the globe, at root this is an argument about China. Bremmer himself writes that "China holds the key." But is it in fact correct to ascribe China's success to the state rather than the market? The answer depends on where you go in China. In Shanghai or Chongqing, for example, the central government does indeed loom very large. In Wenzhou, by comparison, the economy is as vigorously entrepreneurial and market-driven as anywhere I have ever been.

True, China's economy continues to be managed on the basis of a five-year plan, an authoritarian tradition that goes all the way back to Josef Stalin. As I write, however, the Chinese authorities are grappling with a problem that owes more to market forces than to the plan: the aftermath of an urban real estate bubble caused by the massive 2009-2010 credit expansion. Among China experts, the hot topic of the moment is the new shadow banking system in cities such as Wenzhou, which last year enabled developers and investors to carry on building and selling apartment blocks even as the People's Bank of China sought to restrict lending by raising rates and bank reserve requirements.

Talk to some eminent Chinese economists, and you could be forgiven for concluding that the ultimate aim of policy is to get rid of state capitalism altogether. "We need to privatize all the state-owned enterprises," one leading economist told me over dinner in Beijing a year ago. "We even need to privatize the Great Hall of the People." He also claimed to have said this to President Hu Jintao. "Hu couldn't tell if I was serious or if I was joking," he told me proudly.

Ultimately, it is an unhelpful oversimplification to divide the world into "market capitalist" and "state capitalist" camps. The reality is that most countries are arranged along a spectrum where both the intent and the extent of state intervention in the economy vary. Only extreme libertarians argue that the state has no role whatsoever to play in the economy. As a devotee of Adam Smith, I accept without qualification his argument in The Wealth of Nations that the benefits of free trade and the division of labor will be enjoyed only in countries with rational laws and institutions. I also agree with Silicon Valley visionary Peter Thiel that, under the right circumstances (e.g., in time of war), governments are capable of forcing the direction and pace of technological change: Think the Manhattan Project.

But the question today is not whether the state or the market should be in charge. The real question is which countries' laws and institutions are best, not only at achieving rapid economic growth but also, equally importantly, at distributing the fruits of growth in a way that citizens deem to be just.

Let us begin by asking a simple question that can be answered with empirical data: Where in the world is the role of the state greatest in economic life, and where is it smallest? The answer lies in data the IMF publishes on "general government total expenditure" as a percentage of GDP. At one extreme are countries like East Timor and Iraq, where government expenditure exceeds GDP; at the other end are countries like Bangladesh, Guatemala, and Myanmar, where it is an absurdly low share of total output.

Beyond these outliers we have China, whose spending represents 23 percent of GDP, down from around 28 percent three decades ago. By this measure, China ranks 147th out of 183 countries for which data are available. Germany ranks 24th, with government spending accounting for 48 percent of GDP. The United States, meanwhile, is 44th with 44 percent of GDP. By this measure, state capitalism is a European, not an Asian, phenomenon: Austria, Belgium, Denmark, Finland, France, Greece, Hungary, Italy, the Netherlands, Portugal, and Sweden all have higher government spending relative to GDP than Germany. The Danish figure is 58 percent, more than twice that of the Chinese.

The results are similar if one focuses on government consumption -- the share of GDP accounted for by government purchases of goods and services, as opposed to transfers or investment. Again, ignoring the outliers, it is Europe whose states play the biggest role in the economy as buyers: Denmark (27 percent) is far ahead of Germany (18 percent), while the United States is at 17 percent. China? 13 percent. For Hong Kong, the figure is 8 percent. For Macao, 7 percent.

Where China does lead the West is in the enormous share of gross fixed capital formation (jargon for investment in hard assets) accounted for by the public sector. According to World Bank data, this amounted to 21 percent of China's GDP in 2008, among the highest figures in the world, reflecting the still-leading role that government plays in infrastructure investment. The equivalent figures for developed Western countries are vanishingly small; in the West the state is a spendthrift, not an investor, borrowing money to pay for goods and services. On the other hand, the public sector's share of Chinese investment has been falling steeply during the past 10 years. Here too the Chinese trend is away from state capitalism.

Of course, none of these quantitative measures of the state's role tells us how well government is actually working. For that we must turn to very different kinds of data. Every year the World Economic Forum (WEF) publishes a Global Competitiveness Index, which assesses countries from all kinds of different angles, including the economic efficiency of their public-sector institutions. Since the current methodology was adopted in 2004, the United States' average competitiveness score has fallen from 5.82 to 5.43, one of the steepest declines among developed economies. China's score, meanwhile, has leapt from 4.29 to 4.90.

Even more fascinating is the WEF's Executive Opinion Survey, which produces a significant amount of the data that goes into the Global Competitiveness Index. The table below selects 15 measures of government efficacy, focusing on aspects of the rule of law ranging from the protection of private property rights to the policing of corruption and the control of organized crime. These are appropriate things to measure because, regardless of whether a state is nominally a market economy or a state-led economy, the quality of its legal institutions will, in practice, have an impact on the ease with which business can be done.

Table: Measures of the rule of law from the WEF Executive Opinion Survey, 2011-2012

(Note: Most indicators derived from the Executive Opinion Survey are expressed as scores on a 1-7 scale, with 7 being the most desirable outcome.)

It is an astonishing yet scarcely acknowledged fact that on no fewer than 14 out of 15 issues relating to property rights and governance, the United States now fares markedly worse than Hong Kong. Even mainland China does better in two areas. Indeed, the United States makes the global top 20 in only one: investor protection, where it is tied for fifth. On every other count, its reputation is shockingly bad.

The implications are clear. If we are to understand the changing relationship between the state and the market in the world today, we must eschew crude generalizations about "state capitalism," a term that is really not much more valuable today than the Marxist-Leninist term "state monopoly capitalism" was back when Rudolf Hilferding coined it a century ago.

No one seriously denies that the state has a role to play in economic life. The question is what that role should be and how it can be performed in ways that simultaneously enhance economic efficiency and minimize the kind of rent-seeking behavior -- "corruption" in all its shapes and forms -- that tends to arise wherever the public and private sectors meet.

We are all state capitalists now -- and we have been for over a century, ever since the modern state began its steady growth in the late 19th century, when Adolph Wagner first formulated his law of rising state expenditures. But there are myriad forms of state capitalism, from the enlightened autocracy of Singapore to the dysfunctional tyranny of Zimbabwe, from the egalitarian nanny state of Denmark to the individualist's paradise that is Ron Paul's Texas.

The real contest of our time is not between a state-capitalist China and a market-capitalist America, with Europe somewhere in the middle. It is a contest that goes on within all three regions as we all struggle to strike the right balance between the economic institutions that generate wealth and the political institutions that regulate and redistribute it.

The character of this century -- whether it is "post-American," Chinese, or something none of us yet expects -- will be determined by which political system gets that balance right.

LIU JIN/AFP/Getty Images

Argument

A Failure to Communicate

Why doesn't Israel understand the Arab Spring?

Last week, I traveled to Tel Aviv for the Herzliya Conference to speak on a panel about the upheaval seizing the Arab world. The conference is a gathering of the top national security minds in Israel and a venue where officials engage in high-level discussions and often announce major policy decisions. As someone who has spent 12 years involved in the politics of the Arab-Israeli dispute, it was my goal to explain how this conflict affected what I call the Arab Awakening and how Israel should react to recent events in the Middle East.

Merely addressing this crucially important topic, however, ignited anger and skepticism from all sides. A campaign launched by Palestinian activists and amplified by Syrian-leaning newspapers in Lebanon urged Arab participants to boycott the conference. I also received messages on Twitter demanding that I not attend, with some going so far as to say that I was condoning "Israeli apartheid."

In the end, I was present for the final day of the conference, where I spoke in a morning session as part of a five-member panel. The panel's title -- "The Rise of Political Islam Across the Middle East: Arab Spring or Islamist Winter" -- itself reflected a failure to grasp the grand scale and nature of change under way in the Arab world.

Arabs are not faced with a choice between democracy and an Islamist takeover. In fact, most Islamist parties in the region have records of being supremely democratic and suffered under autocratic regimes for demanding reforms when other parties did not. Contrasting the Arab Spring with an Islamist takeover is therefore a false dichotomy -- the people of the region are craving representation, and Islamists have long supported participatory governance.

At the heart of the changes in the region is a democratic impulse common to us all. Both Islamists and secularists share the desire for democratic institutions and personal freedoms. Now that groups like the Muslim Brotherhood have been elected, I noted, Islamist-led democratic transitions in Egypt and Tunisia are a reality. If Islamists want to remain in power, they will, like any other party, have to deliver on popular demands and practice inclusion, tolerance, and respect for women and minorities.

I stressed that what we are seeing in the Middle East today is much more significant than the rise of Islamists. In effect, we're witnessing what columnist Rami Khouri has called "the birth of Arab politics." For the first time, people across the Middle East are organizing political parties, engaging in the decision-making process, and daring to participate in peaceful popular protests on a massive scale.

Such a development, in my view, must be celebrated and facilitated by Israel. I warned the Israeli audience that, if they disparage the new Arab politics, they will only undermine Israel's narrative that it is "the only democracy in the Middle East." Indeed, I went on to say, it is the responsibility of Western and Israeli policymakers to exorcise themselves of their "autocracy addiction" and instead work to build real stability in the Middle East. Israelis must embrace democratic change in the region. Anti-Israeli sentiments may become more prominent as popularly elected governments take power, but it is better to address these challenges head-on than to ignore them, I asserted.

Since the outbreak of the Arab Awakening, the prevailing impulse in Israel is to circle the wagons and turn away from the turmoil in the region. However, I argued, there is a need to look over the horizon. Rather than noting the efforts of transitioning countries to democratize or welcoming new leadership in the region, Israel, itself a democracy, is characterizing the spread of representative governance across the Middle East solely as a threat. Prime Minister Benjamin Netanyahu's description of the Arab Spring as an "Islamic, anti-Western, anti-liberal, anti-Israeli, undemocratic wave" reflects the prevailing security-first mindset.

Ultimately, no one has "lost the Arab Spring to the Islamists," I argued. The democratic opening in the region represents a chance for all to gain, and Israel too has a role to play -- by making a renewed effort to resolve the Palestinian issue. Arabs will not forget that their national narratives are intertwined with the Palestinian narrative, I explained. That is why lasting peace with them requires lasting peace with Palestinians.

The immediate reaction to my opening remarks was an attentive silence. Throughout my short trip, the overwhelming sense I received was that Israelis remain highly skeptical of changes in the region and are understandably fearful of what they will bring. This sentiment was echoed in the remarks at Herzliya by the director of military intelligence, Maj. Gen. Aviv Kochavi, and by Defense Secretary Ehud Barak, who spoke from the podium about turmoil in the region and the immediate threats it poses to Israel. "We are facing a Middle East which will be more hostile," Kochavi noted.

Barak struck a more hopeful note, arguing that democracy in the Arab world will be a positive development in the long run -- yet short-term fears seem to dominate the Israeli psyche. "The skies are clouding over what is known as the Arab Spring," he said.

But I also heard from Israelis who realized that Israel cannot hide from the events shaking the region. Throughout the day, Israelis approached me to commend what I had said, with one going so far as to remark: "This is what Israelis need to hear." These Israelis were, notably, the ones whose horizons went beyond the borders of Israel. They were trying to see changes in the region from the perspective of the Arab people aspiring for democracy, rather than only through the lens of Israel's security concerns.

The day after speaking at Herzliya, I traveled to Ramallah for meetings with notable Palestinian leaders. There, the overwhelming sentiment was one of hopelessness. In fact, one highly connected Palestinian said this was the most difficult period for his people since 1948. He also expressed concern that Palestine's young population -- almost half of which is under age 20 -- had not experienced the heady, nationalist struggle of Yasir Arafat or the hope of the Oslo Accords. This hopelessness, especially among the young, could lead to increased radicalization and more protests.

The entire trip was an important wake-up call. It highlighted the degree to which each side is isolated from the other. Interestingly, some Palestinians and Israelis united over their criticism of me: Palestinians and Arabs lambasted me for attending the Israeli-run conference, and many Israelis remain skeptical of my message that the events of the Arab Spring are not necessarily threatening to Israel. But the divisions between the two sides are becoming more deeply entrenched, and these barriers to engagement will make a future peace agreement more elusive. The world is changing around us, and we must too.

Uriel Sinai/Getty Images