In the age-old contest of economic growth models, state capitalism has seemed to be gaining the upper hand in recent years. Avatars of liberal capitalism like the US and the UK continued to perform anaemically in 2012, while many Asian countries, relying on various versions of dirigisme, have not only grown rapidly and steadily over the last several decades, but have also weathered recent economic storms with surprising grace. So, is it time to update the economics textbooks?
In fact, economics does not say that unfettered markets are better than state intervention or even state capitalism. The problems with state capitalism are primarily political, not economic. Any real-world economy is riddled with market failures, so a benevolent and omnipotent government could sensibly intervene quite often. But who has ever met a benevolent or omnipotent government?
To understand the logic of state capitalism, it is useful to recall some early examples—not the socialist command economies or modern societies seeking to combat market failures, but ancient civilizations. Indeed, it seems that, like farming or democracy, state capitalism has been independently invented many times in world history.
Consider the Greek Bronze Age, during which many powerful states, organized around a city housing the political elite, formed throughout the Mediterranean basin. These states had no money and essentially no markets. The state taxed agricultural output and controlled nearly all goods production. It monopolized trade, and, in the absence of money, moved all of the goods around by fiat. It supplied food and inputs to weavers and then took their output. In essence, the Greek Bronze Age societies had something that looked remarkably like state capitalism.
So did the Incas as they built their huge Andean empire in the century before the Spanish arrived. They, too, had no money (or writing); but the state conducted decennial censuses, built roughly 25,000 miles (40,000km) of roads, operated a system of runners to send messages and collect information, and recorded it all using knotted strings called quipus, most of which cannot be read today. All of this was part of their control of land and labour, based on centrally planned allocation of resources and coercion.
How is it that societies as disparate as the Greek Bronze Age cities of Knossos, Mycenae, or Pylos, the Inca Empire, Soviet Russia, South Korea, and now China all ended up with state capitalism?
The answer lies in recognizing that state capitalism is not about efficient allocation of economic resources, but about maximizing political control over society and the economy. If state managers can grab all productive resources and control access to them, this maximizes control—even if it sacrifices economic efficiency.
To be sure, in many parts of the world, state capitalism has helped to consolidate states and centralize authority—preconditions for the development of modern societies and economies. But political control of the economy generally becomes problematic, because those running the state do not have social welfare or optimal resource allocation in mind. The state capitalism of the Greek Bronze Age or the Inca Empire was not motivated by economic inefficiency; nor did it necessarily create a more efficient economy. What it did was help to consolidate political power.
At a deeper level, the real dichotomy is not between state capitalism and unfettered markets; it is between extractive and inclusive economic institutions. Extractive institutions create a non-level playing field, rents, and narrowly concentrated benefits for those with political power and connections. Inclusive institutions create a level playing field and give incentives and opportunities to the great mass of people.
But herein lies the problem for state capitalism: inclusive institutions require a private sector powerful enough to counterbalance and check the state. Thus, state ownership tends naturally to remove one of the key pillars of an inclusive society. It should be no surprise that state capitalism is almost always associated with authoritarian regimes and extractive political institutions.
This is not an endorsement of unfettered markets. The state plays a central role in modern society, and rightly so. Modern economic growth, even under inclusive institutions, often creates deep inequalities and tilted playing fields, endangering those institutions’ very survival. The modern regulatory and redistributive state can, within certain bounds, help to redress these problems. But the success of such a project crucially depends on society having control over the state—not the other way around.
To argue that state capitalism’s success proves its superiority is to put the cart before the horse. Yes, South Korea grew rapidly under state capitalism, and China is doing likewise today. But state capitalism emerged not because there was no other way to ensure economic growth in these countries, but because it enabled growth without destabilizing the existing power structure. The genius of China’s state capitalism is that it ensured the continued dominance of Communist Party elites, while improving the allocation of resources, not that it alone could have provided price incentives to farmers and then managed liberalization of urban markets.
State capitalism will persist so long as existing elites are able to maintain it and benefit from it—even if economic growth ultimately stalls. And there is a good reason why it eventually will. Sustained economic growth presupposes inclusive institutions, because innovation—and the creative destruction and instability that it wreaks—depends on them. Extractive institutions in general, and state capitalism in particular, can support economic growth for a while, but only the sort of catch-up growth that South Korea experienced from the 1960s to the 1980s, before starting to transform its society and economy more radically.
As the low hanging fruit from catch-up growth is consumed, China, too, will be forced to choose between the economic and social freedom, innovation and instability that only inclusive institutions can underpin and continued economic, political, and social control in the service of the elites who control the state. ©2012/Project Syndicate
Daron Moglu, a professor of economics at MIT, and James A. Robinson, a professor of government at Harvard University, are co-authors of Why Nations Fail: The Origins of Power, Prosperity, and Poverty.