Is 'state capitalism' killing emerging markets?
7/3/2013 12:00:55 PM

That theme has dominated the conventional wisdom, and sold many books, since the financial crisis.

Lately, however, it appears misguided.

As Wall Street sets new earnings records the “miracle economies” have quickly lost their luster. Growth is slumping. Their stock markets have shed more than 20 percent since late 2007.

So what went wrong?

Some fault bureaucrats.

“The full blame for this meltdown, and then some, can be placed at the door of their state-owned companies,” writes Ruchir Sharma, in a recent Wall Street Journal op-ed titled "How Emerging Markets Lost Their Mojo."

Sharma is head of emerging markets for Morgan Stanley. He is the author of a brilliant book called Breakout Nations, which parses why some upstart countries prosper, while most others flounder.

Sharma writes “global markets don't buy the conventional wisdom of the post-crisis years when … books forecast "The End of the Free Market."

That's a reference to a book by Ian Bremmer, author and president of the Eurasia Group, a leading political consultancy.

Reached by phone in London, Bremmer told GlobalPost that he disputes much of Sharma’s thesis. Here’s an edited and condensed interview.

GlobalPost: In the Wall Street Journal, Ruchir Sharma recently argued that the failure of state capitalism is responsible for meltdown in emerging market equities. Do you agree with that assessment?

Bremmer: No. I think there are a lot of things responsible for the meltdown in the emerging market equities.

The first is that the US looks a lot more attractive right now. Growth is picking up, and the energy revolution, of course, is a piece of that. Trade, immigration and the deficit are all part of that.

The Fed is now talking about tapering its bond buying program. That means interest rates are going up. That's going to be a problem for emerging markets in terms of borrowing.

A third piece, of course, is that emerging markets are less stable, because of their middle classes. Economists think of middle classes as good markets for consumer goods, with lots of demand. In contrast, political scientists think of middle classes as citizens who are more demanding of governments. That causes instability if the governments don't respond well.

So, there are many things that have caused emerging markets to take a hit. State capitalism would be quite low on my list.

What does the declining market value of state companies say about the success of state capitalism and the risks to Western capitalism that you outline in your book "The End of the Free Market"?

When I said the “end of the free market” I was not saying that I thought state capitalism was a better system.

Economists rightfully point out that state-owned enterprises are economically inefficient. Having said that, they are extremely politically efficient. They exist to ensure the stability and sustainability of the existing political system. The reason governments have doubled down on state enterprises, especially in China, is not because they don't understand that the private sector is more efficient. It's because that's not their only priority. To pretend it is, that's a mistake.

We used to have a global free market dominated by the West and its multinational corporations. That is no longer true, particularly with the growth of emerging markets, and specifically with China on its way to becoming the world's largest economy. China is becoming larger much faster than it is reforming its state-owned enterprises out of existence.

Why is China pursuing this tactic?

The Chinese still don't innovate very well, so they lift themselves up the value chain by leveraging the attractiveness of the Chinese labor market. Once foreign corporations have invested, China’s weak rule of law means state-owned enterprises can capitalize on the proprietary technology that foreigners have developed.

I should mention that this works for privately owned national champions as well. In a country like China, you don't need to be owned by the state to be state capitalist. You just need to be preferred by the state over Western multinational counterparts in the private sector.

Baidu versus Google would be a good example of this. Huawei, with its ties to the People’s Liberation Army, would be another good example. Neither