January 22, 2008
Q&A: Illiberal capitalism
My recent article Illiberal capitalism: Russia and China charter their own course has prompted some interesting debate. Robert Kagan, foreign-policy analyst at the Carnegie Endowment for InternationalPeace, and I answered some of readers’ questions in a Q&A on FT.com on Tuesday. All the questions and answers can been seen here.
Gideon I was wondering whether you could take the time to answer my questions which were not posted on the Q&A earlier today? My questions are:
(1) Talking of a “Russian- Chinese authoritarian model” blends the two countries together, yet is it not true that many differences exist, and that the Russian Putin model is far more authoritarian, and far more intrusive as far as the economy is concerned?
(2) Is constant meddling by the Russian government in the - thus far undefined -strategic sectors of the economy, not hampering investment and growth prospects, to a far greater extent than in China?
(3) Could one not argue that the Chinese model is “ultra liberal” rather than authoritarian or illiberal? The Chinese claim to be non-dogmatic in their decisions to do business with any country, including those with dodgy regimes such as Sudan, being motivated by commerce and access to natural ressources. The USA is dogmatic as it wants to foster its democratic views upon countries, whereas the Russians are dogmatic as they want to reassert their former geopolitical power in the world. In the domestic economy the Chinese appear far more “laisser faire” than the Russians, or not?
(4) To what extent will the failure to embrace a fully western political model impede growth in Russia and China? In other words, what are the future growth prospects of these two emerging economies in pursuing an authoritarian Russo-Chinese Model in the long-run?
Posted by: Christopher de Vrieze | January 22nd, 2008 at 7:22 pm | Report this commentMr. Rachman,
Your recent column and the Q&A comments discuss capitalism by adding various compound adjectives to the word such as illiberal, state, authoritarian, with the implication that attaching such a modifier to capitalism creates an oxymoron. In fact, when you consider what capitalism means, there is no inherent contradiction.
Capitalism is associated with “freedom” and “democracy”, but it is not synonymous. At the risk of over-simplifying, I will try to define capitalism, which require me to first posit a definition for capital. Going beyond the classical economics textbook definition of capital as a factor of production alongside land and labour, I would extract two key characteristics of capital that also define the capitalist system. Capital may be defined as an enforceable claim on an asset, where that asset may produce positive income in the future (in the form of an income stream or capital gains). Characteristic 1: For such claims to be enforceable, there must be a system of title, and hence property rights and the institutions to enforce them. Characteristic 2: There is a possibility of making a profit from holding the asset (contingent on being able to assert your ownership rights over it per characteristic 1). A capitalist system enables capital to exist, in that it allows an entity or individual to exercise characteristic 1 in order to potentially achieve characteristic 2. You do not need to be free or democratic to have a claim over a potentially profitable asset, it is just that in “free” and “democratic” societies the costs associated with the first characteristic tend to be lower due to the legal infrastructure that is in place that also serves democracy and individual liberties.
Another key feature of capitalism is the price system, but this is a result of the characteristics above, where the market can price the uncertainty of the title claims and the uncertainty and size of the future profits. In places like the US, the premium for the uncertainty of title is usually close to zero (so when we talk about “cost of capital” we think only of the uncertainty of the future cash flows) but in China and Russia this risk premium for uncertain claims is significant. However, if the expected profits are large, investors can overcome this risk premium associated with uncertain claims over the future profits. When the “title risk premiums” are extremely high and the expected profits are low, the price system seems to break down because there are no transactions, since the premium for uncertain claims cannot be overcome. When no transactions occur, there is no trade, and the increased aggregate value-added in a society arising from division of labour is diminished. The system no longer appears to be capitalist.
China and Russia have therefore become capitalist in recent years for slightly different reasons. The expected profits in Russia have increased as energy prices have increased, but there does not seem to have been much of a decrease in the risk of arbitrary confiscation of assets. The “title risk hurdle” has remained high, but with high energy prices filtering through the economy, the expected profits have grown, which entices people to transact, despite potentially not being able to enforce a claim over any profits. With the fall of communism Russia removed the explicit institutional barriers to the price mechanism, so once the title risk is overcome, people will engage in trade as long as the expected profits remain high. This leads to the worrying conclusion that in the absence of extremely high profit expectations (i.e., if energy prices are lower), trade and consequently capitalism will fall off substantially.
China on the other hand has built credibility with investors over time (both foreign and domestic) about its willingness to enforce certain property rights and so has reduced the perceived title risk hurdle. As a second-degree effect, this prompted an increase in expected profits in China, since there was more trade that increased the wealth of the nation, in effect a virtuous circle. It is likely that the Chinese government has been sufficiently convinced that guaranteeing certain property rights is in its interests, given the demonstrated success of the policy to date, which would encourage more confidence that the capitalist system will not fall away that easily in the future.
I do not know how well or badly the Chinese or Russian legal infrastructure operates, but I suspect not as efficiently as in the “democratic” and “free” west. In the west there are synergies operating a legal system that serves multiple purposes. In the US in particular, the legislature is an arm of government and the courts uphold individual liberties, as well as property rights. If the US was not “democratic” and “free” the legal infrastructure would be much more limited in its scope and would likely be less developed and less efficient in enforcing property rights (almost its sole function in a capitalist non-democratic, non-free society). This is an economic rationale that gives one reason why there appear to be such synergies between democracy, freedom and capitalism, but they are not as inter-dependent as one might initially think. Arguably, in places where there is a state infrastructure in place (such as in China with nodes of the communist party having a line of communication through the hierarchy), this could compensate for the lack of legal infrastructure and enable property rights to be enforced better than in a complete institutional vacuum such as in Africa.
The implication in Fukuyama’s article “The End of History” (and those who have subsequently adopted a variant of this ideology) is that there is an inevitable march towards democracy once capitalism takes hold. This seems to assume that an affluent, consumerist middle class will agitate for political change (towards a more democratic system), once it has achieved economic prosperity. However, the chain of logical consequences is much more convoluted and the empirical evidence does not seem to support this to date. The affluent middle classes have a lot to lose from political instability and a lot to gain from the status quo that has generated that prosperity. This is particularly the case with the middle classes who are only one generation out of relative poverty, as is the case in Russia and China.
This analysis perhaps takes an overly economic view, but the purpose was to present a case to decouple words “free” and “democratic” from capitalism. There is an argument about the influence of culture, ideology, etc, on the co-development of freedom / democracy and capitalism but I think I have already written too much at this point.
Posted by: Collins | January 23rd, 2008 at 1:11 am | Report this commentIt is just a question of efficiency.
What social conditions make a right ecosystem for Capitalism to flourish?
1. Stability and Juridical Security.
The Market needs guarantees of Stability. In Spain, Japan, South Korea, Taiwan, Chile…a Dictatorship created the conditions for Juridical Security.
Even the UK needed Cromwell and the US a Civil War which ended with half a million dead and a clear Dictatoship from the North in the South crushing any wishes of Independence from states like Texas, Florida, Georgia….
2. Infraestructure.
If individual property rights were completely respected there wouldn´t be National Infraestructure Projects.
The railways, the superhighways, the water dams…all that means crushing the property rights of millions of citizens.
The US did it (not to mention native americans and the railways), Germany did it (thanks to Bismarck and Hitler), Spain did it….
3. Protectionism
All industrial powers (except the first one, the UK) got their present status thanks to Protectionism, nurturing their own industry…and at the same time searching new markets abroad (which before WWII were largely captive markets from the UK and France: colonies)
India was just a British Dictatorship but completely open to the British industry which just didn´t allow a national industry to develop.
The same did the UK in China which had an important Trade surplus with the UK. Britain just promoted the Opium Wars which were intended to open the Chinese Market to British drugs (imagine if Colombia attacks Ecuador and makes them open their market to Colombian cocaine…)
British behaviour was completely Dictatorial, in fact no other country had so much control over millions of consumers without basic rights.
4. Transparency, Flexibility and Competition.
Once Juridical security and a basic Infraestructure are established the next steps come closer to Liberalism and Democracy.
The Market needs Transparency and Flexibility…and these two items are best guaranteed by Democracy.
So Fukujama is broadly right. Market forces establish different economic hubs which compete for resources and customers and those hubs lead finally to different parties.
Government must guarantee competition, flexibility and transparency…but by its own condition an authoritarian regime lacks the necessary tools to guarantee any of them in an efficient way.
5. Russia and China.
Russia and China have learnt from previous experiences.
First an authoritarian regime to guarantee security, stability and infraestructure.
Then market forces will develop multiple hubs, multiple centers of decission making, multiple economic interests which will have to be defended by competing parties…and that leads to new market demands of transparency and flexibility.
In times of Depression and War there is a common need which only can be guided by the Government so any nation tends to be more authoritarian as happened in the US after 911…
Enrique Costas Mira
Posted by: Enrique Costas Mira | January 23rd, 2008 at 4:45 am | Report this commentLawyer.Spain
Has the supposed contrast between the “authoritarian” capitalism of Russia and China and the “democratic” capitalism of the US not been highly exaggerated in Mr. Rachman’s and Mr. Kagan’s Q and A’s? In my comments concerning Mr. Rachman’s article, I mentioned the increasing lack of freedom in the US during the past seven years. Clearly, in the US, we are not yet Russia or China, but we are certainly closer than we were before George W. Bush took office. I do not see how anyone can dispute this, as long as Guantanamo remains open, the records of the White House remain secret to an unprecedented degree, and the government continues to listen in on our phone conversations and read our emails.
But beyond this, is it not true that American, and by extension western, capitalism is now so entwined with the Chinese variety, at least, that neither could function without the other? For example, suppose China suddenly decided to permit independent labor unions, with the resulting rise in wage rates and labor costs. What would happen to all the “democratic” capitalists in the US and other western countries whose businesses depend on Chinese sweatshops? And what would happen to the US and western European corporate elites who are doing quite well through trade and investment with authoritarian Russia and China, if true democracy took hold in those countries, or, for that matter, in so many others where “stability”, i.e., business as usual, has been considered far more important than democracy? It would be interesting to learn Mr. Rachman’s views in this regard.
Posted by: Roger Algase | January 23rd, 2008 at 10:37 am | Report this commentRe developing new socio-economic and political systems, I believe Fed has just broken some ground. Communism was all about collective responsibility for individual mistakes, nurturing a culture of incompetence and idiotism. This is what eventually broke it. Ever since this route is becoming more and more crowded.
Posted by: Dusan | January 23rd, 2008 at 3:16 pm | Report this commentWhen we combine two of the most successful institutions in human history, the modern corporation and state, then we have arguably, the most powerful force in history. Lord Acton’s oft mentioned quote seems prescient here…
Power tends to corrupt, and absolute power corrupts absolutely.
Posted by: Chris Montano | January 23rd, 2008 at 10:37 pm | Report this commentLord Acton, Letter to Bishop Mandell Creighton, 1887
I think one missing element in the articles is the complicity of those wonderfully perfect Western democracies in the rise of those horrible, nasty “illiberal” capitalists:
- In the case of China, the Western desire to cut production costs (keep inflation down) has led to mass export of manufacturing jobs to China.
It is not just the wages that are lower. As part of keeping the costs down, the Chinese are much less careful about the environmental impact of what they do and health and safety at work is said to be quite terrible too. Also political repression ensures that the worker “ants” don’t get ideas above their station like demanding better working conditions, better hours or more wages.
But hey, how can you continue to be successful, prosperous, liberal Western democracies if you need to worry about what the yellow and brown people do in their backward, poor, illiberal lands?!
- With Russia, it is really more of the same. Thirst for energy (including the explosive Chinese demand which, itself, is caused by the explosive growth in manufacturing on behalf of the West)and the political and economic unacceptability of living more modestly and burning less fossil fuel in the advanced “liberal capitalist” states, causes the democracies in the liberal West to sell their souls to the likes of Putin (and the House of Saud) and keep coming back for more.
In conclusion, the moralising implied in the title and body of the discussion is reminiscent of a pimp living handsomely off his immoral earnings whilst condemning the prostitutes’ lax ways.
Best,
P
Posted by: Pacifist | January 24th, 2008 at 2:17 pm | Report this commentI don’t think that the “hopes that the two countries would embrace the western political model now seem outdated and naive.”
These hopes might be outdated and naive if it were not for our human nature that knows that man doesn’t live by bread alone.
Illiberal capitalism will not last long in dictatorial states like China and Russia.
Adam Smith wrote:
“Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism but peace, easy taxes, and a tolerable administration of justice: all the rest being brought about by the natural course of things.”
If a state does not limit an individual’s economic affairs but limits it in others such as in free speech, free elections, religion, freedom of the press, etc. and if we believe that all men are created equal with unalienable Rights such as Life, Liberty and the pursuit of Happiness (”the natural course of things”) then illiberal capitalism will go the way of communism and socialism.
Posted by: zqll | January 27th, 2008 at 10:16 pm | Report this comment