Jun 26th 2008

Capitalism’s uncertain future

by Daniel Daianu

Daniel Daianu is a former Romanian Minister of Finance

What will the world economy look like 25 years from now? Daniel Daianu says that sovereign wealth funds have major implications for global politics, and for the future of capitalism.

Investment by sovereign wealth funds (SWFs) last year reached a record $50bn or so, and in the first quarter of this year accelerated further. In the deepening financial crisis, and after their severe losses in the sub-prime debacle, Citigroup, Morgan Stanley, Merrill Lynch and UBS all sought liquidity injections from SWFs by selling them equity. These transactions took place against the background of the SWFs' growing visibility in the world economy. Last October, the G-7 finance ministers invited international organisations, notably the IMF and OECD, to consider the role of SWFs − and the IMF, in co-operation with fund owners, is now developing an SWFs code of conduct, and the OECD is identifying best practices for recipient countries. The EU, too, has taken up the whole issue seriously.

SWFs are not new. Decades ago, several countries (Kuwait in 1953, Singapore, Norway, the United Arab Emirates) established SWFs to manage their substantial foreign exchange reserves - essentially oil and gas revenues that couldn't be fully invested in their own economies without endangering stability. Investing abroad was therefore the logical way forward. The rapid and durable rise in energy prices of recent years, together with the exceptional performance of the Asian economies, led to significant growth in the number of SWFs. Currently, SWFs are estimated to control assets worth somewhere between $1.5 trillion to $2.5 trillion, and with rising commodity prices it is thought that this figure will by 2015 have risen to $12 trillion.

The rise of the SWFs looks likely to have an increasingly significant impact on international politics. The reason for this is simple − some of the SWFs belong to countries that had since World War II been ideologically opposed to the western world. China's foreign exchange reserves, for example, had reached more than $1,400bn by late 2007, while those of Russia exceed $400bn − and both are nations with large SWFs. It's therefore possible to place the SWF phenomenon in a broader context of global competition and of diverging national interests - indeed, it is possible to consider this issue in terms of a clash of capitalisms.

In the wake of the fall of communism some analysts focused on a form a competition amongst capitalist systems within the wealthy western world. The influential French economist Michel Albert in the early 1990s wrote a book called "Capitalism versus capitalism" in which he viewed global economic competition as essentially a struggle between the Anglo-Saxon economic model and the continental model in France, Germany and elsewhere. Over the past decade, the concept of "fortress Europe" has also gained currency, and the European economies appeared to be successfully reducing their productivity gap with the US. MIT's Lester Thurow saw a tri-polar world economy emerging, with Japan as the third pole. This vision of economic power in the world shared between America, Europe and Japan was glaringly illustrated by the composition of the Trilateral Commission, whose meetings group leaders from all three.

Nowadays, though, a new global competition between different models of capitalism can also be seen. This reflects momentous changes in the world economy, and underlines their geopolitical implications. China's formidable economic ascent in the last two decades, and India's more recent rise along with that Asia in general, all signal tectonic shifts in the global economy. These economies are characterised by dynamism, and that in turn is reflected in their economic growth, their soaring exports, the size of their foreign exchange reserves and not just their absorption of modern technologies (ICTs) but increasingly their own generation of new technology. China and India each graduate over half a million engineers a year, and the presence of their scientists in top professional journals is more then eye-catching. Both countries are also making big inroads into reshaping the world institutional order that has regulated international affairs since the end of World War II. The debate on reforming International Financial Institutions (IFIs), as well as the causes behind the stalling of the Doha trade round, are examples of this. It is no longer realistic to pursue any real issues of global governance without involving China and India.

Chinese and Indian companies can boast global outreach and are now acquiring significant stakes in companies around the world, including in the west. India's Tata group is to begin production of an extraordinarily cheap car that could be a global phenomenon, and it has bought the two famous brands of Land Rover and Jaguar from Ford, the American giant which, like GM, is going through hard times.

China, along with India and Brazil, is increasingly present in regions of the world where it's strategically important to control scarce, exhaustible resources ranging from industrial minerals to oil and gas. China uses international economic aid as a means of bolstering its credentials in poorer countries, notably in Africa, that have major natural resources. This poses a challenge to both the US and the EU. At the same time, Russia is staging a comeback on the international scene precisely because of the enormous scale of its natural resources. Lukoil and Gazprom have been expanding their operations in Europe by capitalising on EU's high dependence on external supplies of energy, and its lack of a common energy policy.

Asia's remarkable economic progress is re-landscaping competitive hierarchies around the world, and is reducing the west's ability to set the rules of the game. This redistribution of world economic power is also having geo-political effects - these concern regional political and economic dynamics, security alliances, the reform of IFIs, global governance structures, and competition for strategic resources.

This geo-political perspective suggests that the title of Michael Albert's 1991 book could perhaps be paraphrased. In Asia, with the exceptions of India and to some extent Japan, the prevailing form of capitalism has an authoritarian shade and relies on state structures. This type of capitalism hinges on corporatist structures, on industrial policies and selective protectionism. It operates in Russia too, where the state controls the major energy groups. Clearly, economic rationality has to be reconciled with other factors when the state's wider interests have to be taken into account. That's especially true in a world increasingly worried about the scarcity of non-renewable energy resources and in which global warming is creating very complicated trade-offs for policy-making, and where food looks like becoming less plentiful because of climate change pressures.

Not even India, the world's largest democracy, sees eye to eye at a geo-political level with either the US or the EU. That India and the US have come to an agreement on energy and on the major issue of nuclear weapons does not radically change the scope for competition between these different types of capitalism, even if it is possible to argue that a growing rivalry is developing between China and India on which the US could capitalise. In any case, when it comes to reforming IFIs and international trade, India would clearly side with the other emerging economies.

The western world is and will remain the most powerful bloc, economically and militarily, for the foreseeable future. But the US has been weakened by its external deficits and by military overstretch in Iraq and Afghanistan. Its deepening financial crisis also raises major concerns over business governance, with under-regulation and inadequate supervision and America's blind belief in the self-regulating virtues of markets − market fundamentalism − becoming increasingly problematic. How ironic all this must seem to Asians, given the western world's preaching at the time of the Asian financial crisis a decade ago.

The EU too is struggling to manage its growing organisational complexity while tackling various forms of institutional and policy incoherence. China and the other Asian countries, meanwhile, are progressing economically and technologically at a very fast pace − a trend that's likely to continue in the next two decades or so, even if some of their economic momentum is temporarily eroded by the economic woes of the US and Europe. And Moscow is using the Russian Federation's energy-based financial muscle to play once more at global power politics. All these dynamics look more salient still when placed against the backdrop of the worldwide contest for scarce natural resources, the intricate situation in the Middle East and the rivalries in the Caspian Sea region and in Africa.

Authoritarian techniques like direct state involvement in the economy and society are even finding a degree of favour in liberal democracies. This reflects fears of terrorism, along with the need to cope with global warming while securing energy supplies. The debate in the US on the implications of the Patriot Act, and its echoes in the EU's member states is quite telling, and the rise in economic nationalism should also be seen in this light.

Throughout the world we are witnessing the resurrection of a policy paradigm that sees state intervention as an optimal means of achieving results. Policymaking of a type normally associated with a war economy is therefore likely to proliferate, especially when quick responses and the immediate mobilisation of major resources are needed. The deepening of the current financial crisis is also vindicating those who have long cautioned against market fundamentalism. This is a crisis that is bolstering pragmatism and policies that do not confuse free markets with completely deregulated ones.

Capitalism won the Cold War and defeated the communist system. But it is by no means certain that this guarantees the victory of liberal democracy − to use Fareed Zakaria's term for describing the western world. Competition between different types of capitalism has a major geo-political dimension, and, just how the transatlantic relationship in particular, will be managed in the future is a key concern.

Reforms that could bring greater vitality to the western economies are also very important. The EU's Lisbon agenda is a vitally important policy response, yet seems already to have been overtaken by the new focus on global warming and energy security. Now the need is to update the Lisbon agenda, and improve industrial and economic performance.

To sum up, the relative decline of the economic power of the US and EU seems inevitable, in terms of their share of global GDP, industrial production and world trade. But this relative decline, described by the political scientist Nicole Gnesotto in the Summer 2007 issue of Europe's World as "the growing powerlessness of the West", may be accompanied by a rise in its so-called soft power − especially if new countries join the family of liberal democracies. This would be very much in tune with American political scientist Samuel Huntington's idea of the "third wave of democratisation". The expansion of the west's soft power would involve more concern for global issues, such as global warming and international trade, the greater involvement of emerging global powers like China and India in tackling the world's "hot spots" and, not least, a reappraisal of the moral values which have brought economic prosperity and political empowerment to ordinary citizens during modern history. This reappraisal would include paying genuine attention to the concerns of the rest of the world.

This article was provided by EUROPE'S WORLD.

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