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State Capitalism and the Future of Globalization

Ian Bremmer and Alexander Kliment | 24 Nov 2009

For nearly three decades, there were few certainties about the global
order as starkly tangible as the Berlin Wall. Cutting off East from West
both literally and figuratively, it was the most important stitch in the
Iron Curtain, and even on the eve of its collapse in the fall of 1989, few
could imagine a world without it or the potentially apocalyptic divisions
it represented.

Yet when the Wall finally fell, eventually taking all of Soviet
communism with it, a new set of certainties about the global political
and economic order was born. And none has been more pervasive or enduring than the belief that the
spread of markets and the advance of globalization are irreversible, even inevitable. Countries
imprisoned for half a century or more behind the Iron Curtain needed only to stagger out into the light of
a changed world, in which capitalism had triumphed, history had ended, and the road towards a market-
driven utopia was an open, if occasionally bumpy one.

Or so the thinking went. But 20 years later, there is reason to question our assumptions, not least
because a new specter has crept into view in recent years: the rise of state capitalism, an economic
approach in which governing elites recognize the power of markets, but seek to manage and control that
power for the direct benefit of the state itself. And in the lengthening wake of the global financial crisis,
there is perhaps more skepticism about free markets now than at any point since 1989.

-O-

Nowhere has this trend been more glaringly apparent than in Russia, which was in many ways the focus
of the West's greatest "End of History" hopes 20 years ago. Far from blossoming into the pro-Western,
market-oriented democracy that the 1990s shock therapists dreamed of, the successor to the Soviet
Union has developed into a quasi-authoritarian petro-state, strongly committed to a form of tightly
managed oligopolistic capitalism, in which elements of free market ideology coexist with strict
government control over sectors that the Kremlin considers vital to Russia's economy and security.

Prime Minister Vladimir Putin -- who as president from 2000-2008 presided over the creation of
Russia's current political and economic structure -- has explicitly rejected Soviet-style central economic
planning, and on many occasions has expressed a belief in the power of capitalism and markets to raise
Russia's living standards and global power. But in his conception, which enjoys the support of President
Dmitry Medvedev and much of the Russian political elite and population, the interests of the state
should take precedence over the interests of investors, foreign or domestic.

Consequently, over the past decade, the Russian state has significantly expanded its role in the economy,
supported by a consensus among Russian elites that views the 1990s as a modern "time of troubles,"
during which the political and economic weakness of the Russian state enabled oligarchic interests to
gain control of key national assets, use them in ways that harmed Russia's interests, and exert undue
influence over the Kremlin itself. The lesson that Russia's current elites drew from the 1990s was
overwhelmingly -- and not without some justification -- that "markets" and "democracy" bring about
chaos and weakness.

The Russian state's expansion into the economy has, of course, been most notable in the energy sector,

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where the government espouses a rigorous form of resource nationalism. When Putin came to power, the
state controlled less than 10 percent of Russia's oil output. By the end of Putin's presidency, the state
controlled nearly 50 percent. To reclaim this share of energy production, the state has used legal and
regulatory harassment to pressure privately controlled companies to cede control to the state. The most
egregious example was the jailing in 2003 of Mikhail Khodorkovsky and the state takeover of his Yukos
oil company. But several years later, the state pressured the Shell-led consortium at the Sakhalin-2 oil
and gas project to cede a controlling interest to Gazprom for below-market value. And Gazprom is still
quietly waging a regulatory war against ExxonMobil's Sakahlin-1 project, in an effort to gain control of
its gas exports.

The growing role of the state has not, however, been limited to oil and gas. In other sectors, including
aerospace, shipbuilding, arms exports, civilian nuclear power and other advanced technologies, the
Kremlin created an array of new state-controlled companies, as well as a special category of quasi-
sovereign goskorporatsias (state corporations) that give the state control over these sectors and, equally
importantly, provide lucrative revenue streams to the officials who manage them. As a result, a new
class of wealthy "state capitalists" has emerged in Russia, and there is a significant overlap between
governing and economic elites.

The ad hoc growth of state control in Russia has contained a strongly nationalistic component as well.
This became codified in the so-called "strategic sectors law" of 2008, which identified 42 sectors of the
economy -- chiefly in energy and military-related sectors -- in which foreign investors must gain special
approval from a prime ministerial commission in order to obtain significant stakes in Russian
companies.

There are, of course, still large swathes of the Russian economy controlled by powerful private
financial-industrial conglomerates. There are, for example, no massive state companies in most
consumer-driven sectors -- including retail, construction, real-estate, automobiles, and wireless
communications. Even in the strategically important and lucrative metals sector, which has given rise to
some of Russia's wealthiest private businessmen, the state has until now largely relied on state-friendly
oligarchs to protect its interests, rather than directly assuming control over the sector or forming a state
company along the lines of Gazprom.

But the state keeps private business on a tight leash, and relations between oligarchs and the state are
guided by two principles. The first is "social responsibility." Under new, unwritten "rules of the game"
that Putin established in the first months of his presidency, the state allows oligarchs to keep their
wealth, and the Kremlin will even intercede on behalf of favored oligarchs in business deals both
domestically and abroad. But in exchange, oligarchs are expected to steer well clear of politics, and to
acquiesce to the state's economic and political interests when called upon to do so -- whether by putting
their personal fortunes to work in developing Russia's far-flung regions; suppressing prices for staple
products during an electoral cycle; keeping workers on payroll to prevent social instability; or giving
state companies preferential prices for building materials and services.

The second principle of the relationship, which has become particularly clear during the economic and
financial crisis, is the state's preference for "control without responsibility" -- that is, maintaining
leverage over these oligarchs, but not taking direct responsibility for keeping their hundreds of
thousands of workers on payroll. Many of Russia's largest, and most over-leveraged, private companies
were able to weather the financial crisis only on the strength of massive loans from the state or state-
controlled banks. In exchange, the state took large stakes in these companies as collateral on the loans.

Earlier this year, there was strong concern in the markets that the state would use these points of
leverage over companies, particularly in the metals sector, as entry points for state takeovers. But this

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didn't happen. Instead, the state has used these points of leverage to exert greater control over business
decisions by the oligarchs in question. As the economic crisis has rippled across Russia's beleaguered
metals, mining, and manufacturing towns, companies have come under strong political pressure to
minimize outright layoffs, even at the expense of good economic sense. Instead, companies have cut
work schedules, slashed salaries, pushed older workers into early retirement or shunted younger ones
into make-work jobs.

The severity of the financial and economic crisis' effects on Russia have prompted some discussion of
reforms designed to decrease the state's role in the economy, relax the most stringent aspects of Russia's
resource nationalism, and "modernize" or "diversify" the Russian economy. Medvedev has been
particularly vocal on this score, though Putin -- whose voice is still the only one that really matters -- has
been more lukewarm on the question of far-reaching reform. Some marginal changes are possible in the
coming years, but broadly, the relationship between state and economy in Russia is unlikely to be
dramatically reworked. The current prevailing interests are simply too entrenched. Russia's political and
economic elites are committed to a form of state capitalism that will continue to countervail, or at least
put to its own uses, the spread of globalization and free markets.

-O-

Despite the Western financial crisis and the global recession it helped create, ideas, information, people,
money, goods and services continue to cross borders at unprecedented speed. But for all the utopian
forecasts of globalization's most passionate champions, all that traffic hasn't rendered borders irrelevant,
and no one has forgotten how walls are built.

And while Russia is, in the context of the Berlin Wall's fall, the most striking example of expectations
unmet, this trend is hardly an exclusively Russian story. The governments of several countries, including
major oil importers and exporters, have created and cultivated national oil companies as an extension of
their foreign and economic policies. The 13 largest energy companies on Earth, measured by the
reserves they control, are now owned and operated by governments. Saudi Aramco, Gazprom (Russia),
China National Petroleum Corporation, National Iranian Oil Corporation, Petróleos de Venezuela,
Petrobras (Brazil), and Petronas (Malaysia) are all larger than any international oil company.
ExxonMobil, the largest of the multinationals, ranks just 14th in the world. Collectively, multinational
oil companies produce just 10 percent of the world's oil and gas, and hold about 3 percent of its reserves.
By contrast, state-owned companies now control nearly 80 percent of global crude oil reserves.

And as the Russia example shows, the story extends well beyond energy. Across a broad range of
economic sectors, China and Russia are leading the way in the strategic deployment of state-owned
enterprises, and other governments have begun to follow their lead. In sectors as diverse as defense,
power generation, telecoms, metals, minerals, and aviation, a growing number of emerging market
governments, not content with simply regulating markets, are now moving to dominate them. This state-
corporate activity is fueled in part by the emergence of a new class of sovereign wealth funds. States
with large holdings in the currencies of other countries are establishing risk-taking funds meant to
maximize their return on investment -- and perhaps their political influence. But by manipulating
markets to achieve political ends, these governments have upended the assumption that they will no
longer interfere in the free flow of ideas, information, people, money, goods and services.

It's tempting for multinational companies to believe they can rely for the lion's share of their future
growth on access to hundreds of millions of new consumers in emerging market countries like China,
Russia, India and others. But they must be prepared for these newly empowered governments -- which
are increasingly skeptical of Western-style free market capitalism's ability to deliver robust and
predictable long-term growth -- to favor domestic companies at their expense and to close doors in their

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faces. Political leaders that have embraced state capitalism have plenty of built-in political and economic
incentives to create new laws, rules, and regulations that boost local competitors at the expense of
outsiders.

Most multinationals operating in emerging market countries already know that they must diversify their
exposure to risk -- that they can't afford to bet everything on one or two markets. But they should also
have workable plans in place should a shift in the political winds begin to push them toward the exits.
And today, political winds that many thought had calmed with the fall of the Berlin Wall are tearing
through those markets as strongly as ever.

Ian Bremmer is president of Eurasia Group and co-author of "The Fat Tail: The Power of Political Knowledge for Strategic
Investing" (Oxford University Press, 2009). Alexander Kliment is a Russia analyst at Eurasia Group.

Photo: Russian Prime Minister Vladamir Putin (Photo by Marina Lystseva, licensed under GNU Free Documentation
License 1.2).

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