Enter the Dragon

Why “state capitalism” is China’s biggest knockoff.

Like China, the West has long used state resources to bolster industry.Credit Illustration by JOHN RITTER

Currency wars, trade battles, threats of economic sanctions—these days, it’s hard to open a newspaper without encountering at least one story about rising tensions between China and the United States. With all the talk of how China could displace the U.S. as the leading financial superpower, it is easy to forget that economic disputes between Beijing and Western capitals are nothing new, and that in the past they sometimes went well beyond diplomatic démarches. In the late eighteenth century, for example, the inhabitants of Great Britain were drinking so much tea from imperial China that a big trade deficit had arisen between the two countries. China demanded payment in silver, which was putting pressure on the Exchequer and the pound sterling. Eager to find a product that the Chinese would import, the English settled on opium, which was produced in parts of India that they controlled. In 1773, the governor-general of Bengal broke up the local opium-smuggling cartel and granted the London-based East India Company a monopoly, which endured for more than fifty years. During the next five decades, China’s annual imports of British-supplied opium went from seventy-five tons to nine hundred.

The rulers of imperial China took exception to this development, which was turning millions of their subjects into shiftless dope fiends. They tried banning the import of opium, to little effect. Finally, in 1839, a commissioner of the Canton region clamped down on the illegal trade, forcing British merchants to hand over thousands of chests of opium, and sent Queen Victoria a letter declaring, “We mean to cut off this harmful drug forever.” In London, there was outrage. Rather than negotiate with China, Lord Palmerston, the Foreign Secretary, dispatched a naval flotilla.

Confronted with iron-hulled steamships and powerful cannons, the Chinese military was hopelessly outmatched; the British seized control of Canton and the surrounding areas, killing thousands. Palmerston and his allies loftily insisted that the intervention was in the service of broader British interests and of the principle of free trade, which London was promoting throughout the Empire. The Times of London nonetheless dubbed the conflict the Opium War, and the young William Ewart Gladstone, in one of his early parliamentary speeches, said that the British flag “is become a pirate flag, to protect an infamous traffic.”

In 1842, the Chinese government was forced to sign the Treaty of Nanking, promising Britain more than twenty million silver dollars in reparations (around half a billion dollars in today’s currency), minimal tariffs on its goods, docking rights at five Chinese ports, and sovereignty over Hong Kong. Fifteen years later, complaining of trade impediments, France, Russia, and the United States, all of which had growing business interests in the Far East, joined the British in a second Opium War. Under the terms of the Convention of Peking, in 1860, China agreed to open up more of its ports to foreign exporters, to pay more in reparations, to allow British ships to transport indentured Chinese laborers (“coolies”) to the United States, and to legalize the opium trade. The country’s economic subjugation—the Chinese Communists later referred to the period as the “century of humiliation”—may have ultimately helped bring down the Qing dynasty and usher in civil war and revolution. But it certainly cleared up Britain’s trade deficit.

Today, of course, China can’t be pushed around as easily. It is now the world’s second-largest economy. Two of the four biggest banks in the world are state-controlled Chinese corporations, as are two of the ten biggest oil companies. With economic might comes strategic influence, evident in China’s increasingly active role in Africa and Latin America. Many observers foresee a coming clash of civilizations between an economically vibrant yet politically illiberal developing world, led by China, and a slow-growing democratic West. “China poses the most serious challenge to the United States since the half-century Cold War struggle with the Soviet Union,” Stefan Halper, a veteran foreign-policy expert, writes in his book “The Beijing Consensus: How China’s Authoritarian Model Will Dominate the Twenty-first Century” (Basic; $28.95).

Note the word “model” in the subtitle of Halper’s book. The elements of this model, in most accounts, include keeping key areas of the economy under state ownership or state control; using government subsidies and currency manipulation to promote exports; setting up sovereign wealth funds to buy companies and influence in the West; and making backdoor deals with equally autocratic states to insure access to oil and other natural resources. In all of this, the unifying theme is a reliance on the guiding hand of the state rather than on private decisions made in the marketplace. In “The End of the Free Market: Who Wins the War Between States and Corporations?” (Portfolio; $26.95), Ian Bremmer, the president of the economic consultancy firm Eurasia Group, writes that, until recently, “private wealth, private investment, and private enterprise appeared to have carried the day. But as the sun sets on the first decade of the twenty-first century, that story has already become ancient history. The power of the state is back”—and back in a way that “threatens free markets and the future of the global economy.” Picking up the same theme, the Wall Street Journal recently published a front-page story about how the rise of Chinese “state capitalism” was provoking a global backlash. “Since the end of the Cold War, the world’s powers have generally agreed on the wisdom of letting market competition—more than government planning—shape economic outcomes,” the Journal reported. “China’s national economic strategy is disrupting that consensus.”

Things could hardly be otherwise. The astonishing transformation since China adopted, in 1978, what Deng Xiaoping described as “socialism with Chinese characteristics” poses a big challenge to Western ideas about politics and about economics—but it is important to distinguish between the two. Within the political realm, what remains of the reassuring notion, popularized by Francis Fukuyama, that liberal democracy is the only system compatible with modernity? In promoting the development of a dynamic, competitive economy within the confines of a one-party state, the descendants of Chairman Mao seem to have arrived at a new social contract that says to the governed: Go and engage with the global economy, set up businesses, invest, make as much money as you can, but leave the politics to us. Russia, Cambodia, and other rapidly developing countries, too, have shifted in an authoritarian direction.

From a Jeffersonian perspective, what’s going on may look like repressive regimes foisting unpopular policies on peoples striving to be free. But, as Halper, who served in the Nixon, Ford, and Reagan Administrations, points out, these policies enjoy a good deal of popular support. “Given a choice between market democracy and its freedoms and market authoritarianism and its high growth, stability, improved living standards, and limits on expression—a majority in the developing world and in many middle-sized, non-Western powers prefer the authoritarian model,” Halper writes. If this unsettling trend isn’t arrested in the coming decades, he adds, “the United States will be left in a world unsympathetic to the democratic values and principles that have guided Western progress for more than two centuries.”

That may be overstating the case: once you look beyond Hu Jintao and Vladimir Putin, the political futures of China and Russia are far from clear. History suggests that “market authoritarianism” is often a transitional stage of development. During the nineteen-seventies and eighties, a number of Southeast Asian countries employed it to drag themselves out of poverty. Today, South Korea, Thailand, and Indonesia are democracies, of sorts. Singapore, on the other hand, remains essentially a one-party city-state. Who can say for sure which of these paths Russia (already a democracy, albeit a distinctly curtailed one) and China will end up following? Despite recent developments, China, in particular, is still a pretty poor place, with a per-capita G.D.P. of about three thousand dollars in 2008. By 2050, according to a recent study from the Carnegie Endowment, this figure will rise to about thirty-three thousand dollars, which would place China roughly where Spain is today. It is hard to disagree with George Magnus, an economic adviser to UBS Investment Bank, when he says, in his new book, “Uprising: Will Emerging Markets Shape or Shake the World Economy” (Wiley; $34.95), that “some sort of change in China is inevitable”— that, “sooner or later, rising living standards and the spread of modernity through the country are going to generate a growing public clamor for political participation and institutional reform.”

But it’s in the economic realm that Halper, Bremmer, and many other analysts have fundamentally misrepresented the Western pattern of development. Apart from economics textbooks and reports from the International Monetary Fund, the free-market model of capitalism that China, Russia, and other fast-growing nations are supposedly supplanting has never actually existed. The closer you look at how countries such as Britain and the United States became prosperous, the less you see of laissez-faire and the more you see of government intervention. Lord Palmerston’s “gunboat diplomacy” in defense of the opium trade may have been an especially bald version of state capitalism, but the basic strategy of enlisting state power in pursuit of commercial advantage, and vice versa, has been anything but the exception. Far from subverting the Western way of doing business, the developing world is, at last, stealing some of its tricks.

Take free trade. From Lord Palmerston to Secretary of State Hillary Clinton, Western officials have long demanded that countries open their domestic markets to foreign competition. But Britain and the United States embraced free trade as an ideal only after they had built up manufacturing industries that could dominate those of foreign rivals. The rise of Britain as an economic power can be dated to the fourteenth century, when King Edward III banned the import of woollen cloths from Belgium and Holland, the market leaders in textiles. In the centuries that followed, Britain’s trade policy was geared toward promoting its wool and cotton industries; duties were placed on exports of raw wool, to encourage British merchants to move into the more lucrative business of assembling finished cloths.

It wasn’t just the textile industry that received favorable treatment. In 1721, the government of Robert Walpole placed a range of tariffs on all manufactured imports, erecting a protective wall around businesses that created the Industrial Revolution. A century later, while the heirs of Adam Smith were expounding the theoretical virtues of free trade, Britain retained some of the highest import tariffs in the world: more than fifty per cent on many manufactured goods. Those levies stayed high until the eighteen-sixties, when the country’s competitive advantage in textiles, steel, and other industries was firmly established. As the late economic historian Paul Bairoch stressed, the idea that Britain rose to economic dominance through free trade is nonsense.

The same is true of the United States. Even before 1791, when Alexander Hamilton published his famous “Report on the Subject of Manufactures,” Congress used tariffs to protect favored industries. During the War of 1812, which was precipitated in part by trade disputes, it doubled import duties on manufactured goods, to twenty-five per cent. A few years later, the levies were raised to an average of forty per cent. Then Abraham Lincoln raised them again, to roughly fifty per cent. Ha-Joon Chang, an economist at the University of Cambridge, has observed that Lincoln, revered as the Great Emancipator, “might equally be labeled the great protector—of American manufacturing.”

During the half century after Lincoln’s Presidency, the business-backed Republican Party was in power for most of the time, and tariffs on manufactured goods remained at forty to fifty per cent, the highest levels anywhere. It was during these years that the U.S. economy grew to rival the economies of Britain and Germany in industries such as iron and steel and chemicals—all of which benefitted from protection. Even during and after the First World War, when President Woodrow Wilson, in his Fourteen Points, elevated free trade to a goal of U.S. policy, hefty tariffs remained in place. (For some agricultural products, such as sugar and ethanol, they still exist—greatly to the advantage of big U.S. agribusinesses such as Cargill and Archer Daniels Midland, which otherwise would struggle to compete with foreign suppliers. And that’s aside from the billions that these companies have received in government subsidies.) The fact is that not one of today’s economic powers practiced free trade during its developmental stage. “Free trade economists have to explain how free trade can be an explanation for the economic success of today’s rich countries,” Chang notes, “when it simply had not been practiced very much before they became rich.”

China, Korea, and other rising economies are often reproached for using government money and influence to bolster home industries to the disadvantage of foreign competitors, a practice that is known as “industrial policy,” and is frowned on by international trade law. Such discriminatory policies are also referred to as dirigisme—a clue that the concept didn’t originate in the Far East. After the Second World War, the government of France’s Fifth Republic created “national champions” in strategic areas of the French economy, such as transportation, energy, and aerospace. The policy gave rise to big companies like Air France, the French railway operator S.N.C.F., the utility company E.D.F., and the aeronautics contractor EADS, all of which are partly or wholly owned by the French government. It continues under President Nicolas Sarkozy, a devoted interventionist, who made his reputation as finance minister by bailing out Alstom, a large engineering firm, and encouraging a merger between the drug companies Aventis and Sanofi in order to avert a threat of foreign takeover.

But industrial policy long predates General de Gaulle. It was Walpole who wrote, “Nothing so much contributes to promote the public well-being as the exportation of manufactured goods,” and the British government long subsidized exporters while imposing tight quality standards on them to safeguard the British brand. “These policies are strikingly similar to those used with success by the ‘miracle’ economies of East Asia, such as Japan, Korea, and Taiwan, after the Second World War,” Chang has argued in “Bad Samaritans: The Myth of Free Trade and the Secret History of Capitalism” (2008). “Policies that many believe, as I myself used to, to have been invented by Japanese policy-makers in the 1950s . . . were actually early British inventions.”

Here, too, the United States was quick to follow Britain’s lead. In 1791, Hamilton proposed a series of policies to help transform America into an industrial economy, including export subsidies, prizes for industrial inventions, and public investment in infrastructure. During and after the Civil War, the federal government, by providing generous land grants and cheap financing, was instrumental in opening up the Great Plains and directing the expansion westward. The Central Pacific and Union Pacific railroads were both government-chartered companies that benefitted from large land grants, not to mention vast sums in government loans.

U.S. industrial policy may be less visible these days, but it still plays a key role in maintaining our competitive edge. Much of this assistance comes through the Pentagon, which, by paying for research-and-development projects that private investors would be reluctant to finance, has helped to create three of our biggest export industries: commercial aircraft, military aircraft, and computers. The Boeing 747 and many other modern jetliners were developed from designs for military aircraft. Fairchild Semiconductor, which helped pioneer the development of the silicon transistor, in the nineteen-fifties, was a military contractor, as were many other technology firms that helped launch the modern computer industry, such as Texas Instruments. And, famously, the Internet was created by the Pentagon’s Defense Advanced Research Projects Agency (DARPA), which continued to operate it until 1990.

The Department of Defense remains the indispensable client for many major U.S. manufacturers, such as Boeing, Lockheed, and Honeywell. Despite laws that direct federal officials to obtain the best terms available for taxpayers, personal links still appear to influence dealings between the Pentagon and big defense contractors, as a steady stream of procurement scandals suggests. On those rare occasions when foreign firms manage to secure large military contracts, Congress often objects. (Witness the continuing row over Airbus’s bid for an order of refuelling tankers.) To be sure, domestic favoritism exists in many other countries, perhaps to an even greater extent. But since the United States spends almost as much on its military as the rest of the world combined, no other government department comes close to exerting the commercial sway of the Pentagon.

Then, there’s the financial sector. Developing Asian countries have been criticized for propping up struggling banks rather than allowing market forces to operate. During the recent financial crisis, of course, the United States—along with other prominent members of the World Trade Organization, like Britain and Germany—found itself doing precisely the same thing. As for the U.S. bailouts of General Motors and Chrysler, a case can be made that they violated W.T.O. rules, not that anybody is going to call Washington to account. Compared with these naked exercises in industrial policy, some of the Chinese infractions that have most exercised the W.T.O. seem relatively minor. Last year, China was criticized for preventing foreign firms from selling books, movies, and music directly to Chinese customers; instead, Western entertainment companies like Disney and Time Warner have had to work with local distributors. Such measures are plainly discriminatory and protectionist, but they have hardly prevented big U.S. corporations from making inroads into the Chinese markets. In the first half of this year, General Motors’ Chinese subsidiary, which is a joint venture with Chinese manufacturers, sold more than a million cars and trucks, a jump of almost fifty per cent over last year. For the first time, the Detroit automaker sold more cars in China than it did in the United States.

Ian Bremmer concedes that many American firms are doing well in China, and he relegates the prospect of a trade showdown with China to a distant threat. In a chapter about the challenges ahead, he asks what will happen if and when “Chinese companies use their growing influence to lobby for greater support against foreign competition. . . . In other words, what happens if China closes the door?” The likely answer is that China would get burned and quickly turn back. A trade confrontation with the U.S. and other Western countries—an Opium War in reverse—would undermine the very basis of China’s success: the export of cheap manufactured goods.

Both Bremmer and Halper devote considerable space to China’s recent efforts to secure its future supplies of energy and natural resources, which have involved cozying up to repressive regimes in places like Zimbabwe, Sudan, and Iran. Halper, in particular, emphasizes the threat posed by China’s dealings among aid-dependent countries. He considers China’s rise in Africa to be a “tragedy,” though his alarmism doesn’t do justice to the complexity of the topic, or, indeed, of the region. Part of the evidence he presents for China’s malign influence is the fact that it helped build a hospital, an irrigation project, and a vocational-training center in Ghana—a multiparty democracy that, mystifyingly, is on his list of repressive African regimes. If this is a strange example to have chosen, it’s not the only one. Bemoaning China’s success in limiting American influence, he describes China’s transactions with oil-producing Angola, which has been left ravaged by three decades of a failed but spectacularly bloody insurgency. He points out that China offered development loans with none of the good-government strictures that the I.M.F. sought to impose. He doesn’t point out that the United States was, together with apartheid-era South Africa, a chief sponsor of the insurgency, which cost the lives of three hundred thousand people and displaced nearly a quarter of the country’s population. (In fact, much of the support came during the Reagan Administration, in which Halper served as a member of the State Department’s Bureau of Political-Military Affairs.) As for whether I.M.F.-style conditions on foreign assistance really have a positive effect on freedom and democracy, the evidence is far from clear.

“The use of oil, gas, and other commodities as political tools and strategic assets,” Bremmer writes, “can be an essential part of state capitalism,” and he notes that three-quarters of the world’s oil reserves are owned by national oil companies. There is no disputing that securing access to natural resources is a major strategic objective in foreign policy, but that’s equally true of Western countries and their developing rivals. During the late nineteenth century, tales of diamonds, gold, and other precious minerals in limitless quantities helped spark the Scramble for Africa. After the First World War, Britain and the United States, conscious of the future importance of the Persian Gulf ’s vast oil reserves, helped install a series of pliable desert monarchs who granted access to Western oil companies on favorable terms. In 1953, two years after Mohammad Mosaddegh, the democratically elected Prime Minister of Iran, nationalized the British-owned Anglo-Iranian Oil Company, the C.I.A. helped organize a successful coup against him. Needless to say, the United States continues to stabilize “friendly” oil-exporting governments, like the Kingdom of Saudi Arabia and the Sultanate of Oman, with extensive military and technical assistance.

The heavy hand of American domestic and foreign policy in shaping economic outcomes tends to get ignored in current policy debates, in which economic issues are usually cast in ideological terms, devoid of their historical context. Yet our amnesia comes with a cost: the idealized free-market model that is supposedly under threat offers only the harshest of solutions to the energy problem. If demand for oil continues to soar in the face of limited supply, prices will eventually skyrocket, forcing the United States and other oil importers to cut drastically their consumption of gasoline. There’s an alternative to this market-administered shock therapy: a vigorous energy policy that raises taxes on carbon fuels, subsidizes energy conservation, and provides cheap financing for the development of renewable energy sources. But a major obstacle to such a policy is the popular misconception about the role of the state in economic development.

There are some encouraging signs of revisionism. In a recent book, “The Great Betrayal,” Clyde Prestowitz, a former U.S. trade negotiator who founded the Washington-based Economic Strategy Institute, includes a chapter on “How America Really Got Rich.” And in the book “Losing Control: The Emerging Threats to Western Prosperity,” Stephen D. King, the chief economist at HSBC, the London-based global bank, notes, “Western governments have used the methods of state capitalism for hundreds of years in their bid to shape the world around them. . . . The idea that market forces alone led to the West’s success is nonsense.”

Unfortunately, in policy circles—and among much of the general public—the old mantras about the free market and private enterprise continue to dominate. In seeking to broaden access to private health insurance, the Obama Administration was accused of plotting a takeover of the entire health-care industry. In cutting taxes and boosting federal spending to avert a depression, it was accused of embracing socialism. Even supposedly serious economists lend support to these views, arguing that the dysfunctional health-care industry is best left to its own devices, or that the eight-hundred-billion-dollar stimulus program has had virtually no impact on jobs and on G.D.P. This is what comes of forgetting the critical role that states have played in nurturing, protecting, and financing their industries, as well as in taxing and taming them. The greatest danger that Western prosperity now faces isn’t posed by any Beijing consensus; it’s posed by the myth of the free market. ♦