Response to the End of Free Markets

Paul Fischer

Comparative Economics

5/28/2016

Shirley Gedeon

Rise of a New System, Response

The Ten Largest Corporations

Corporation	Base of Operations	Ownership*
ICBC	Xicheng District, China	1
Construction Bank of China	Beijing, China	1
Agricultural Bank of China	Beijing, China	1
Berkshire Hathaway	Omaha, Nebraska, USA	2
JP Morgan Chase	New York, New York, USA	2
Bank of China	Beijing, China	1
Wells Fargo	San Francisco, California, USA	2
Apple	Cupertino, California, USA	2
ExxonMobile	Irving, Texas, USA	2
Toyota	Toyota, Japan	2

*1 - State Owned 2 - Private Corporations Traded Publicly 3 - Privately Held Corporations

Source: Forbes Global 2000 (note: Forbes Global 500 ceased in 2003)

The Ten Largest Nations in the World (Aggregate E. U.) by Total GDP, 2014

Nation	GDP (US billions of dollars)
European Union	18,510
United States of America	17,419
China	10,354
Japan	4,601
Brazil	2,417
India	2,049
Russian Federation	1,861
Canada	1,785
Australia	1,455
Korea, Republic	1,410

Source: World Bank

Multinational Corporate Growth and Regulation

The numbers and size of the multinational corporations have multiplied enormously. This is reflected both in raw data as well as media coverage of that raw data: the Forbes magazine stopped covering the top 500 corporations just over a decade ago and established the new global 2000 list which is annually produced. Metrics critical to analysis of markets have now ceased to be relevant.

Expiration of media coverage and attention on a select number of keystone leaders has not occurred and this change is due to growth among multinational corporations, and not to a fundamentally unanswered call for comprehensive analysis. Such a need would be expressed during a point of rapid economic contraction of the sort not seen in modern markets. Justice is contemporarily meted out by the invisible hand of the free market, which has historically dominated even the mixed markets of today and created a low level of necessitated oversight or analysis. That is reflected in the rapid expansion of the numbers of multinational corporations by the tens of thousands in the decades after 1970.

There have been changes to the political make-up of the nations which corporations that play a role in the world market are based in. This is a result of both geographical shifts of markets as well as additive gains to extant public markets by authoritarian or hybrid democratic corporations. Substantive indicators of this change in market have become resurgent in the last decade.

In the decades prior to this the top ten corporations were generally publicly traded and read like a grocery bundle of the average American consumer. Today the list stands as a reflection of the near equal mix in the world’s population of those living in free democracies versus hybrid-democratic and authoritarian states. The extreme spreads of authoritarian markets, in which monopolistic behaviors are the norm, translate to fat tails and require a greater relative sample size to gauge efficacy and trends. It has already been established that the mechanisms of evaluation have remained the same after accounting for growth in terms of markets and numbers of multinational corporations, shifting popularly in media from 500 to 2,000 in the early 2000s.

Market inefficiencies are not to be expected as a result of this disconnect between consistent levels of analysis and changing political backgrounds extant in modern markets. There are two phenomena which can be identified which play a role in ensuring this: liberalization of existing free markets and unification of those markets. While carefully engineered corporate structures have entered the global economy as a result of decreased transportation, communication, and commodity prices the political setting for extant corporations has also dramatically changed.

The state may have begun to play a greater role in the United States of America during the recent recession but this concludes a long period, which continues today, of lowered levels of interference, engineering, or support. Member nations of the European Union as well as other free democracies globally have seen dramatic movement towards a libertarian utopia from a vision of a communist utopia (not to be misinterpreted that either would occur under any circumstances naturally). Free democracies globally have found ways to exert greater levels of freedom within their markets.

European markets also reflect well the trend of existing democratic nations towards greater unification, again noting some breaks in application to the United States. While not a new trend, with foreign corporations first challenging American dominance in the middle of the Cold War, it is one which had accelerated in recent decades. This is found in the sudden presence of a European economic power unrivalled since the colonial period, and is a change which must be considered in evaluating the levels of analysis necessitated by markets and is consequence to enormous levels of foreign direct investment across the globe.

State Capitalism

In the twenty-first century a distinct form of economic engineering has emerged which is individual to nations that embrace it that is known as state capitalism. This is a trend independent of socialism in which industries are engineered by the state. The outcome is a political victory for the state, which ensures a similar stability and has been seen in socialist domination of oil-producing nations including Venezuela. Bureaucratic control of certain industries ensures that the market is generally free and limits the exposure to government interference by any industry. A short period of interference may be a success politically and boost stability at a minimal cost to the industry, but a prolonged period without a commitment to public resources could transform into a liability for both state and industry.

Having described state capitalism, it is now appropriate to describe the geopolitical effects of free markets, perhaps in previous decades brought to a point of liberalization which is inefficient given minimal costs of regulation and the capacities of the industries, such as media earlier discussed, that allow regulation. When nations with free markets adopt a state capitalist stance, it may be more threatening to authoritarian governments even than a free market. The latter governments are incapable of demonstrating compromise and so are unable to reciprocate the move. This also gives the capitalist side of state capitalism a permanence which subverts authoritarian intent to spread.

On a final note, it is also worth exploring the insulation state capitalism provides to truly free markets. While buffer zones may be some sort of a defensive maneuver, it is also possible that uniform state capitalism may bring more hybrid democracies out of the functional norms of authoritarian states, or from under authoritarian control. That is an approach in which state capitalism is not the answer to preserve free markets but instead one of the many mechanisms described above which determine the actuality of regulation and the nature of markets. Misinterpretation of state capitalism as an escape route rather than as a shield could be fatal for an accurate economic forecast; the means used by capitalism for preservation and expansion cannot by definition be singular in nature.

Brief History to Capitalism - Response and Summary

Early economic theory is rooted in liberalism as an extreme reaction to the oppressive nature of feudalism. After many years of serfdom and servitude, which provided security at a steep price in terms of goods and liberties, the industrial wealth brought extinction to manorial systems of commerce. Limits and cautionary trends were established almost as quickly as the concept of capitalism was established. There are two primary sources of this: foreign intervention (much of the world still lived under manorial systems) and, later, actual necessities for regulation as monopolistic corporations arose out of cronyism in postwar America and other nations.

That which provided the greatest impetus for growth during the period of capitalistic development was the elimination of mercantilism by establishment of fair global markets and currency exchange. Nations relied on mass media and fair elections to propagate control, rather than on manipulation of markets or winning of gold in wars or by other means. Elements of mercantilism remain. These include using economic control for domestic political victories and the importance of maintaining a favorable trade balance.

Use of foreign policy to protect international economic interests also remains a critical part of the government’s role which remains today. The beneficiaries of such remnants can be individuals or institutions. How this is integrated into state capitalism will be examined next.

Definition and Expansion of State Capitalism

The difference between state capitalism and free-market is the individual nature of state capitalism. It should be possible to establish some marking traits of at what point state capitalism emerges from a free-market economy or from one attempting utopian communism in a similar way to that which it is possible to distinguish mixed market capitalism from anarcho-capitalism. State capitalism has an organic relationship with but is not synonymous to authoritarian or command economies, and is instead best described as a tool which can prevent free-markets from collapsing into such economic conditions as to necessitate total government intervention or which can bring a nation towards a command economy by mechanically emphasizing the role of the government.

It is best used when particular nadirs in marginal costs of regulation occur individual to nations, which is why it was not effective (or extant) in the middle ages when technological progress was in stasis or during the early industrial revolution as technological progress outstripped all nations ability to develop for around a century. One could describe national socialism in this sense, though dividing markets into compartmentalized unregulated industries turned out to be an abysmal worst of both worlds scenario. Welcoming foreign investment from corporations such as Fanta, already a subsidiary of Coca-Cola, meant that these divisions, perhaps enough to limit domestic investment and allow rudimentary engineering of the economy, yielded bizarre results as certain industries became completely flush with foreign investment and attempted to project that investment upon others.

Just as state capitalism is a tool between command and free economies, there are many tools which determine how the state capitalism operates. These intermediaries include national oil and gas corporations, state-owned enterprises, privately owned national champions, and sovereign wealth funds. The first can be used to show the nature of resource nationalism and the last allow western governments to achieve political goals with economic windfalls from developing and emerging countries.

National oil and gas corporations provide fundamental resources. As state-owned enterprises have entered and dominated the global reserves, multinational corporations such as ExxonMobile, a top ten company, are reduced to providing auxiliary roles in those markets. Even though the state-owned companies can sell on the same market now, competition is prohibited, creating a favorable disequilibrium for them. This is evident from food production to uranium extraction so the trend is by no means limited to oil.

The favorable disequilibrium created by the companies is nullified by the role of state capitalism, which subjects those companies to unprofitable decisions, such as gouging prices (and customers) outside of the realm of rationality in order to achieve national goals. Profits from these sources play a direct role in the development of sovereign wealth funds. Such funds are ways for free-market governments to exert economic influence like an authoritarian state as well as a way for state capitalist governments to extract funds from profitable state-owned businesses.

10 Largest Commodity Financed Sovereign Wealth Funds 2016

Sovereign Wealth Fund	Origin	Nation
Government Pension Fund - Global	Oil	Norway
Abu Dhabi Investment Authority	Oil	UAE - Abu Dhabi
SAMA Foreign Holdings	Oil	Saudi Arabia
Kuwait Investment Authority	Oil	Kuwait
Qatar Investment Authority	Oil and Gas	Qatar
Public Investment Fund	Oil	Saudi Arabia
Abu Dhabi Investment Council	Oil	UAE - Abu Dhabi
Kazakhstan National Fund	Oil	Kazakhstan
National Welfare Fund	Oil	Russia
International Petroleum Investment Company	Oil	UAE - Abu Dhabi

Data: SWFI 2016

Export and natural resources do not provide substantial cash flows for a free-market, so the way that it is possible to exert such influence as those funds allow is to provide direct funding for them from taxpayers and federal reserves in foreign currency. This can be used by authoritarian governments as well under certain circumstances. Such funds are tremendous economic opportunities and have existed for many decades. Public use of the term is barely a decade old, which predicates the secretive nature of the largest and earliest funds.

Many of the tools described serve two functions. In the same way that sovereign wealth funds have allowed investment of otherwise stationary reserves in free-market economies, authoritarian states have found ways of using these to their advantage by making them secret and investing heavily in organizations such as Blackstone. This money then circulates in a normally volatile market, but is controlled by an authoritarian state, giving undisclosed insight as to the nature of market developments. The scale of this development is dramatic: by the late 2000s there was more invested in those funds than was collected by the American government from taxpayers. OPEC is another example of how embracing economic liberalism can help state capitalist economies, rather than moving a nation towards free-markets.

State Capitalism Around the World - Response

Vladimir Putin remains a dedicated state capitalist. His work is described as a use of state capitalism to enforce potential goals for his political party. State capitalism emerged as a scapegoat in early Bolshevik Russia, but has today been the means by which the formerly communist juggernaut is able to swallow capitalism in general. A certain level of repression has been present, with a very distinct reaction compared to such Chinese violence.

Much of the nature of state capitalism in Russia is personality-driven, and Putin has had an enormous individual effect, combined with publicity and high approval, on the country as President and Prime Minister. It is clear that Dmitry Medvedev has not deviated from the course already blazed.  Repression has not been limited to protesters, and was also used to establish and protect Russian state interests in industries, allowing foreign companies only to hold a stake with a regular loss.

Tactics employed by state capitalism under Putin include armed police battalion deployment, the arrest of former oil and gas oligarchs, and establishment of restrictive trade barriers. Support for the protests was provided by the Communist Party and the oligarchs found solace among foreign Western investors who had hoped to grab Russian oil interests. Tariffs will be addressed in greater detail shortly, but when a trademark of state capitalism includes the use of funds and economic policies to win political victories, tariffs eat state funds and erode political goodwill.

One thing to add is that state capitalists to use sovereign wealth funds to undermine foreign regulations and engineering of markets or to break them in their favor. The ability of China to use this tool, with a few billion dollars, to exacerbate the economic crisis and ultimately require around 600 billion in rescue loans, is described with an account of Blackstone. During the financial crisis, these sources of cash could also be used to keep nations afloat and determine the nature of the recovery.

The concept that Russia and America have traded nuclear weapons for such reserves in foreign currency is indicative of the general nature of a shifting geopolitical goal. Both the Soviet Union and the United States swore to never use violence to obtain goals during the Cold War. That has today become a reality, and with an emphasis on the lack of an actual national opposition in the Iraq and Afghanistan wars, was a reality by the time Bremmer’s wrote his book. State capitalism has been used by Russians and Americans to both undermine and uphold free markets in recent past.

Response to the Challenge

The challenge is described as threefold in nature. The most important challenge being faced is that of the international tariff. By definition, this represents the sort of state intervention which in a free global economy, nearly always results in market inefficiencies. Even as nations pledged at the G20 summit not to impose tariffs, dozens were put in place during periods of economic turmoil.

Grounds for the decision are found in the security provided by an effective system of tariffs. It is harmful to facilitate competitors and in a competitive market governments will seek to maximize opportunities for growth in industries which pay taxes and will seek to punish those that pay taxes elsewhere. At the risk of unemployment and price disequilibrium, a government will destabilize some markets given the opportunity to.

That opportunity is provided by state capitalism, in which engineering can also include deconstruction. The liquidity of funds in a globally backed system of banking gives assurances that resources will still be available and investment will continue after tariffs are imposed. This is also the phenomenon which makes them particularly ineffective.

In state capitalist countries the imposition of a tariff essentially acts as a boycott or prohibition, and the investment is made anyway, and the chain of expenses, as well as growth, before the Federal Government collects the sum entirely back is dramatically shortened. This is because the economy is engineered and there is not a system for substitution, which would undermine the tariff. Truly free markets do not suffer this issue as severely, and require broader and more unwieldy tariffs to truly create a disequilibrium in the economy.

The same way a nation might use regulatory or police action to counter price gouging, foreign competitors selling a product cheaply can be countered with tariffs. Examples include the United States’ tariffs on Brazilian sugar and Russian tariffs on imported automotive parts. These are useful choices because political opposition and demonstration resulted in violence in Russia while the American tariff proved ineffective. The removal of farm subsidies and dramatic drop in food surplus by 40% in recent years buried American attempts at protectionism for the agricultural industries.

It appears clear, then, that in order to break a state capitalist economy it would be necessary to provoke widespread tariffs within that economy. This allows elimination of foreign reserves, sovereign wealth funds, and guts oil or resource companies. That happened in China as state-owned oil companies were subject to price ceilings and unable to declare losses, nearly leading to the nation’s dissolution around the time it joined the World Trade Organization and gained the security of investment. The shock was not sudden, however, as a similar crisis in oil in which Russia took a tariff in order to see America squirm, laid the groundwork for that nation’s ultimate dissolution and China remains in good, if not yet a superpower, standing.

Source:

Bremmer, I. (2010). The end of the free market: who wins the war between states and corporations?. European View, 9(2).