INTL 703 CASE STUDY – Emerging marketsPlease read through this article from the Economist about the rise of statecapitalism. The case study questions are at the end of the article. Emerging-market multinationalsThe rise of state capitalismThe spread of a new sort of business in the emerging world will cause increasing problems Jan 21st 2012 | From the print edition OVER the past 15 years striking corporate headquarters have transformed the great cities of theemerging world. China Central Television’s building resembles a giant alien marching acrossBeijing’s skyline; the 88-storey Petronas Towers, home to Malaysia’s oil company, soar above KualaLumpur; the gleaming office of VTB, a banking powerhouse, sits at the heart of Moscow’s newfinancial district. These are all monuments to the rise of a new kind of hybrid corporation, backed bythe state but behaving like a private-sector multinational.State-directed capitalism is not a new idea: witness the East India Company. But as our special report this week points out, it has undergone a dramatic revival. In the 1990s most state-ownedcompanies were little more than government departments in emerging markets; the assumption wasthat, as the economy matured, the government would close or privatise them. Yet they show no signs of relinquishing the commanding heights, whether in major industries (the world’s ten biggestoil-and-gas firms, measured by reserves, are all state-owned) or major markets (state-backedcompanies account for 80% of the value of China’s stockmarket and 62% of Russia’s). And they areon the offensive. Look at almost any new industry and a giant is emerging: China Mobile, forexample, has 600m customers. State-backed firms accounted for a third of the emerging world’sforeign direct investment in 2003-10. With the West in a funk and emerging markets flourishing, the Chinese no longer see state-directedfirms as a way-station on the road to liberal capitalism; rather, they see it as a sustainable model.They think they have redesigned capitalism to make it work better, and a growing number ofemerging-world leaders agree with them. The Brazilian government, which embraced privatisation inthe 1990s, is now interfering with the likes of Vale and Petrobras, and compelling smaller companiesto merge to form national champions. South Africa is also flirting with the model.This development raises two questions. How successful is the model? And what are itsconsequences—both in, and beyond, emerging markets? The law of diminishing returnsState capitalism’s supporters argue that it can provide stability as well as growth. Russia’s wildprivatisation under Boris Yeltsin in the 1990s alarmed many emerging countries and encouraged theview that governments can mitigate the strains that capitalism and globalisation cause by providingnot just the hard infrastructure of roads and bridges but also the soft infrastructure of flagshipcorporations.So Lee Kuan Yew’s government in Singapore, an early exponent of this idea, let in foreign firms andembraced Western management ideas, but also owned chunks of companies. The leadingpractitioner is now China. The tight connection between its government and business will no doubtbe on display when the global elite gathers in the Swiss resort of Davos next week. AmongWesterners there, government delegates often take the opposite view to those from the privatesector: Chinese delegates from both sides tend to have the same point of view, and even the samepatriotic talking-points.The new model bears little resemblance to the disastrous spate of nationalisations in Britain andelsewhere half a century ago. China’s infrastructure companies win contracts the world over. Thebest national champions are outward-looking, acquiring skills by listing on foreign exchanges andtaking over foreign companies. And governments are selective in their corporate holdings. Overall,the Chinese state has loosened its grip on the economy: its bureaucrats concentrate on industrieswhere they can make a difference. Let a thousand mobiles bloomYet a close look at the model shows its weaknesses. When the government favours one lot ofcompanies, the others suffer. In 2009 China Mobile and another state giant, China NationalPetroleum Corporation, made profits of $33 billion—more than China’s 500 most profitable privatecompanies combined. State giants soak up capital and talent that might have been used better byprivate companies. Studies show that state companies use capital less efficiently than private ones,and grow more slowly. In many countries the coddled state giants are pouring money into fancytowers at a time when entrepreneurs are struggling to raise capital.Those costs are likely to rise. State companies are good at copying others, partly because they canuse the government’s clout to get hold of their technology; but as they have to produce ideas of theirown they will become less competitive. State-owned companies make a few big bets rather than lotsof small ones; the world’s great centres of innovation are usually networks of small start-ups.Nor does the model guarantee stability. State capitalism works well only when directed by acompetent state. Many Asian countries have a strong mandarin culture; South Africa and Brazil donot. Coal India is hardly an advertisement for efficiency (see article). And everywhere statecapitalism favours well-connected insiders over innovative outsiders. In China highly educatedprincelings have taken the spoils. In Russia a clique of “bureaugarchs”, often former KGB officials,dominate both the Kremlin and business. Thus the model produces cronyism, inequality andeventually discontent—as the Mubaraks’ brand of state capitalism did in Egypt.Rising powers have always used the state to kick-start growth: think of Japan and South Korea inthe 1950s or Germany in the 1870s or even the United States after the war of independence. Butthese countries have, over time, invariably found that the system has limits. The Chinese of allpeople should understand that the best way to learn from history is to look at its long sweep.But it may take many years for the model’s weaknesses to become obvious; and, in the meantime, itis likely to cause all sorts of problems. Investors in emerging markets, for instance, need to watchout. Some may be taking a punt on governments as much as companies. State-capitalistgovernments can be capricious, with scant regard for minority shareholders. Others may find theirsubsidiaries or joint ventures in emerging markets pitted against state-backed favourites.Another concern is the impact of the model on the global trading system—which, at a time when thelikely Republican nominee for president wants to declare China a currency manipulator on his firstday of office, is already at risk. Ensuring that trade is fair is harder when some companies enjoy thesupport, overt or covert, of a national government. Western politicians are beginning to lose patiencewith state-capitalist powers that rig the system in favour of their own companies. For emerging countries wanting to make their mark on the world, state capitalism has an obviousappeal. It gives them the clout that private-sector companies would take years to build. But itsdangers outweigh its advantages. Both for their own sake, and in the interests of world trade, thepractitioners of state capitalism need to start unwinding their huge holdings in favoured companiesand handing them over to private investors. If these companies are as good as they boast they are,then they no longer need the crutch of state support. STATE CAPITALISM CASE STUDY QUESTIONS SHORT ANSWER (5*10 = 50 points)Please answer the following questions. The first three questions are takenfrom the Economist article. The final two questions are more critical thinkingquestions; you will be evaluated on the basis of your own analysis.1. How does the article define state capitalism in the 21st Century?2. Explain how some emerging markets nations see state capitalism as a viableand sustainable model of free market capitalist economic development.3. According to the article, when does state capitalism work? When does statecapitalism not work?4. In your opinion, should the West implement the model of state capitalism todevelop their economies? Why or why not?5. In your analysis, does the rise of state capitalism mean ‘the end of the freemarket? Why or why not?