Sunday, September 19, 2010

The free market's nasty secret.....

The free market's nasty secret

The End of the Free Market (Who Wins the War Between States and Corporations?) by Ian Bremmer

Reviewed by Mladen Bonev

Ian Bremmer's book describes the ongoing competition between big multinational corporations on one side and state-owned companies such as Russia's Gazprom and China's CNOOC on the other. The focus is mostly on natural resource companies. The author's sympathies are clearly stated - he is on the side of the multinationals like Exxon Mobile, BP and Halliburton.

Bremmer is deeply concerned with the fact that state-run companies and funds are becoming increasingly powerful and are
being allowed to use state resources. He presents this competition as a struggle between state capitalism and free markets. The subtitle says it all.

The book logically starts with an overview of the current situation in the global marketplace. As the author writes on p 17:
In 2000, a report by the Institute for Policy Studies dropped a bombshell: Comparison of corporate sales of the largest multinational companies with the gross domestic products of the world's wealthiest countries revealed that 51 of the world's 100 largest economies were corporations; just 49 were countries. According to the report, General Motors had become bigger than Denmark, Daimler/Chrysler bigger than Poland, Mitsubishi bigger that Indonesia, Wal-Mart bigger than Israel, and Sony bigger than Pakistan. In January 2006, a report from a respected commentator estimated that the top 100 multinationals collectively accounted for one third of world economic output and two thirds of global trade.
The rise of the multinationals is remarkable, and even in the global recession they preserved and some even multiplied their financial and economic muscles. This summer, for example, the market capitalization of Exxon Mobil was about US$315 billion and that of BP - about $130 billion, even after the Gulf of Mexico oil spill.

Thus, in the list of 181 countries arranged by their nominal
gross domestic product (GDP) for 2009, Exxon Mobil would take the position number 30, ahead of countries like Argentina and South Africa.

At the same time, the big multinational companies do not function like contemporary democratic states - they have no parliaments and no courts. Such a company could be likened to a dictatorship state with a dictator chief executive officer (CEO) at the top, helped by his council (board of directors).

For a minor violation, every "citizen" can get deported (fired). The CEO usually has absolute power and the top executives are paid handsomely. Exxon's CEO Rex Tillerson, for example, is receives $4 million in compensation, Halliburton CEO David J Lesar $6 million and McDonalds' CEO James Skinner at least $16 million (data from Yahoo Finance). These numbers exceed by far the compensation of the US president.

The big companies are also very focused on their areas of expertise and their products. Microsoft, for instance, has a market cap of about $220 billion, which puts it ahead of Denmark. While the
government of Denmark has to worry about many different things, Microsoft's executives are focused only on software. The big multinationals apply their efforts in a single direction, which makes them very powerful in their disputes with different governments.

During the past 30 years, the big corporations, feeling their strength, have energetically fought for globalization and free trade. They have urged their governments (mainly in the US, West Europe and Japan) to
secure free markets for them through international treaties and organizations. Thus, through the diplomatic work (and sometimes through the military clout) of their governments, the multinationals have overcome the trade barriers used by other countries to defend their domestic industries.

In the face of these developments, countries like Russia, China, Brazil and some others have realized that without state support their own companies will not be able to stand to the big multinationals. Accepting free trade, international competition and rapid privatization in the period 1993-2000, Russia, for instance, almost lost large parts of its natural resources to international capital.

For his discussion of state capitalism, Bremmer considers mostly China, where the communist government in the late 70-ties decided to create special economic zones on the east coast that mimicked free-market economies. The experiment was very successful and gradually spread further inland. For 30 years, China has enjoyed fast economic growth while preserving its communist government. Discussing this growth, Bremmer clearly shows concern that state capitalism (mainly its Chinese version) endangers free markets and restricts the possibilities for the big multinationals. However, it is not clear why the author is so defensive of these companies.

Bremmer does not give an exact definition of "free markets", but from the context it is clear that this means unrestricted commercial activities of the multinational corporations. The expectation is that their freedom will maximize growth and profits. It is also assumed that profits from the corporations will then trickle down to the rest of the population and will benefit everybody.

As real life shows, though, this assumption is not quite true. Maximizing profits is usually done through payroll trimming (to reduce cost),
outsourcing and subcontracting. Many US manufacturing companies have outsourced their operations abroad and thus have practically deprived the United States of valuable productive capacity.

To improve efficiency, the corporations are growing like snowballs, absorbing smaller companies and merging among themselves. This is destroying the middle class through the destruction of small businesses and redistribution of wealth. The wealth inequality has drastically increased and the purchasing power of the consumers has decreased.

Also, it is not clear why growth for the sake of growth of the big corporations is something positive and beneficial for mankind. Very recently, we saw how uncontrolled growth in the US and the United Kingdom housing markets caused a malignant bubble.

It is more than obvious by now that free markets do not regulate themselves. On the contrary, unregulated market activities tend to cause bubbles and crashes. Joseph Stiglitz recently expressed very eloquently: "Celebrated results, such as Adam Smith's invisible hand, did not hold; the invisible hand was invisible because it was not there." [1]

The word "multinational" explains that these corporations do not entirely belong to any particular nation. At present, the
companies on the Standard & Poor's 500 index in the US derive about 40% of their earnings from abroad. This share is steadily increasing and at some point will exceed 50%. So far, companies like Exxon Mobile and Halliburton are still headquartered in the US, but already large units of them are stationed abroad.

The workforce of the multinational companies is - not surprisingly, but with not-too-obvious implications - also multinational: it is spread all over the world and its American part is decreasing. We can observe a process of decoupling; the business interests of the multinationals deviate further and further away from the national interests of their "countries of origin". The American multinationals, for example, are becoming more and more independent of America. It is a well-known fact that large parts of their profits and tax breaks are invested abroad.

In this situation, it is not clear why it is justifiable to spend American taxpayer
money for their well-being. In the present crisis, with high unemployment in America and many other ordeals, the top executives of Exxon, Halliburton and the likes are still paying themselves tens of millions of dollars in salaries. In many cases these corporations have behaved irresponsibly and disrespectfully to sovereign states. One vivid example is the oil spill in the Gulf of Mexico caused by BP.

Bremmer defines state capitalism as a "system in which the state dominates markets primarily for political gain". Then he says he hopes state capitalism is doomed. But he never explains why state capitalism is so bad. Is "political gain" something wrong?

The essence of China's ideology about markets and state capitalism can be understood from the interview given by Premier Wen Jiabao to CNN's Fareed Zakaria in September 2008. Here is a full citation of what Wen Jiabao said:
The complete formulation of our economic policy is to give full play to the basic role of market forces in allocating resources under the macroeconomic guidance and regulation of the government.

We have one important piece of experience of the past 30 years, that is to ensure that both the visible hand and invisible hand are given pull play in regulating the market forces."
Up to here, the text is cited in Bremmer's book. The continuation of Wen's statement, however, is not in the book. Here is this extremely important continuation.
If you are familiar with the classical works of Adam Smith, you know that there are two famous works of his. One is The Wealth of Nations. The other is the book on the morality and ethics. And The Wealth of Nations deals more with the invisible hand, that is, there are the market forces. And the other book deals with social equity and justice. And in the other book he wrote, he stressed the importance of playing the regulatory role of the government to fairly distribute the wealth among the people.

If in a country most of the wealth is concentrated in the hands of the few, then this country can hardly witness harmony and stability.

The same approach also applies to the current US economy. To address the current economic and financial problems in this country, we need to apply not only the visible hand, but also the invisible hand.
As we see, the Chinese premier balances market forces with social justice. Further in the interview, Wen says more about this, involving morality in economics:
I very much value morality, and I do believe that entrepreneurs, economists and statesmen alike should pay much more attention to morality and ethics. In my mind, the highest standard to measure the ethics and morality is justice. That's why in the morning when I answered the question, I said that I believe in the veins of the economist, we should see the blood of morality.

When we think about economy, we think more about the real elements concerning the company, the capital, the market, the technology, so on and so forth. And we might forget about the other sort of elements that work behind the scene, and these factors are also affected by the visible factors like conviction and morality. Only when we combine these two kinds of factors, can we put in place a full picture of the DNA of the economy.

It is true in the course of China's economic development, some companies have actually pursued their profits at the expense of morality and we will never allow such things to happen. We will not allow economic growth at the expense of the loss of morality because such approach simply can not sustain. That's why we advocate the corporate, occupational and social ethics." [2]
Wen has worded his statement very carefully. Most likely, this is not an improvisation. Therefore, this text reveals the essence of the Chinese state capitalism: the invisible hand of the market forces is coordinated with the visible hand of social justice, morality and ethics. This visible hand is the "political gain" that Bremmer criticizes. This political gain, in my opinion, should not be criticized, but appreciated.

Praising the free market, Bremmer does not provide convincing arguments why it is so good. True, the invisible hand of the market can sort out efficient and non-efficient technologies as well as competitive and non-competitive companies. But the market should not be worshiped as a god - after all, it is just a part of the complex, multidimensional human activity in our world. Free-market forces left to themselves have brought to the world crisis of 2007-2008, which is still continuing.

It has become clear that certain restrictions and regulations should apply, and every country has the freedom to design its own regulations and rules. In this setting, China's state capitalism can be viewed as a special system of market rules and regulations specific for that country, whose efficiency should be measured by practical results. It is a well known fact that for the last 30 years, from the moment of its birth, Chinese state capitalism has been very efficient and has provided remarkable economic growth (in the range of 10% yearly) and wealth creation.

During the peak of the crisis in 2007-2008, the big US banks and other financial institutions like AIG were on their way to collapse due to free-market forces, before the American government interfered with huge sums of money in order to bail them out. This was obviously a political action, intended for a political gain. Also, the very existence of government-sponsored enterprises such as mortgage guarantors Fannie Mae and Freddie Mac demonstrates the deep involvement of the US government in the housing market for political purpose. There are many other examples when the American government and other Western governments have interfered in the market. Central banks do this on a regular basis. However, Bremmer does not call this state capitalism. Clearly we see here double standards.

State capitalist China and the multinational corporations have benefited handsomely from the globalization. There are also numerous losers: the unemployed, the underemployed, and more generally the lower middle class in the Western World. However, while China's rulers have pledged to take care of the well being of their entire country, the profits of the multinationals have benefited only a few - their executives, the insiders, and the large shareholders. Regular investors and even pension funds did not benefit much. For the past 10 years the S&P 500 index is down, the major Western stock markets are down.

The essential part of the book is at the end, in the last fifth chapter called "Meeting the Challenge". In this, the author discusses measures to contain China's state capitalism. The reader meets double standards there again. After talking up free markets and fair competition, Bremmer adds a section titled "Keep Investing in Hard Power". A full citation from p197 is appropriate:
But over the next several years, it is hard power that will ensure that the United States remains an essential component of the world's political and economic stability, whatever the power of state capitalism to undermine American influence in other areas.

The erosion of US soft-power advantages has already begun as emerging states, foreign firms, and new ideas compete with American rivals for shelf space and screen time. Whatever their limitations, America's hard-power advantages are more durable. The United States now spends nearly as much on its military capacity as all its potential competitors combined. It continues to outspend China by nearly ten to one and Russia by about twenty-five to one.
I agree. Supported by aircraft carriers and numerous military bases, multinationals like Exxon Mobile feel more secure and are able to compete comfortably. Exxon and Halliburton, as we know, got very sweet deals in Iraq. Calling this "free markets", however, is somewhat stretched.

It is very disappointing that the author has not included a section called "Keep Investing in Science and New Technologies". Many people forget that America gained its world prominence through new technologies - the telephone, autos, television, electronics, computers, software. Microsoft and Google did not need the Pentagon in order to compete globally.

Bremmer is the president of Eurasia Group, a global political risk research and consulting firm. He has written for the Wall Street Journal, Washington Post, Newsweek, Foreign Affairs, and other publications, including articles published by Asia Times Online (see "related articles" links); he has also published several books. Obviously, he is a very well-informed author. It is sad to realize that this competent and experienced writer finds it necessary to appeal to America's "hard power" for its survival instead to its inventiveness and flexibility.

1. Joseph Stiglitz, "Needed: a new economic paradigm", Financial Times, August 19, 2010.
2. For the full transcript of the Wen Jiabao interview, click here.

The End of the Free Market (Who Wins the War Between States and Corporations? by Ian Bremmer. Portfolio, Penguin Books, 2010. Price US$26.95, 230 pages.

Mladen Bonev is an independent political observer based in Bulgaria.

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