Rise of the False Reformers

Leaders like Xi and Modi were expected to streamline their economies and slash state enterprises. Don’t hold your breath

Photo illustration by 731; Photographs by Getty Images (2); NASA (2)

Over the past year leadership changes in many of the world’s biggest emerging markets, such as China, India, Indonesia, and Thailand, have created hopes of dramatic economic liberalization among citizens of those countries and foreign investors. Media reports cast the new men in charge of the two most populous countries—Indian Prime Minister Narendra Modi and Chinese President Xi Jinping—as once-in-a-generation reformers who could streamline their lumbering economies by slashing state enterprises and reducing waste.

These hopes are likely to be dashed. Modi, Xi, and every other supposedly visionary new leader across the developing world won’t dislodge state capitalism or seriously liberalize their economies. Instead, Leviathan will stay in control of the economy, eventually depressing growth and undermining the entire world’s chance to boom.

Although emerging markets have posted impressive growth rates over the past decade, weathering the global slowdown of the late 2000s better than most developed nations, high-growth nations such as Brazil, China, India, Indonesia, and Thailand have rarely adhered to a strict free-market script. They all maintain extensive state control of many parts of their economies. In China, state-owned enterprises (SOEs) make up almost all of the 20 biggest companies by valuation; in Brazil, India, Indonesia, and Thailand, the government still controls or has vast influence over many of the largest companies.

In the past decade state companies in many of these nations have become more entrenched and have learned how to lobby powerful officials—a relatively new phenomenon in places like China or Indonesia. For example, as Xi began his transition to leadership in 2012 and early 2013 and made clear he wanted to pursue economic reforms, state-owned enterprises, such as China Mobile, pushed back hard, pressing their case heavily with government officials, according to several Chinese academics. Some SOE bosses argued that their companies, though propped up with loans, were even more profitable than they had been a decade ago; in the first half of 2013 the largest state companies saw profits increase more than 18 percent from the year before, a very impressive figure. Other executives stressed that in a region where China faces increasingly hostile neighbors, state companies were critical to maintaining government dominance of important resources and of industries essential to national security.

Xi, meanwhile, has trumpeted his commitment to maintaining state capitalism. At one session of the National People’s Congress, he told attendees: “The strength of the state-owned enterprises cannot be trimmed. Instead, they need to be strengthened.” In the year following the announcement of reforms in 2013, Chinese banks continued to approve loans to highly indebted state companies. Private companies bidding on energy and construction projects in China complain that SOEs still monopolize the bidding process.

Xi’s ultimate goal is to keep the Communist Party in control, and state companies are a powerful instrument for control. In many other developing nations, state capitalism is also a tool too strong for leaders to discard, no matter how reformist they claim to be. In Thailand, for instance, many of the first generation of elected leaders, such as former Prime Minister Thaksin Shinawatra, who ruled from 2001 to 2006, had little actual interest in democracy. They deepened state control of the economy as they were chewing up democratic institutions. Thaksin and later his sister, Yingluck, who was prime minister from 2011 until a coup in May, used state capitalism to favor political allies and destroy opposing politicians. The army, which has even less interest in democracy than Yingluck and Thaksin, claimed the coup would allow for serious political and economic reforms. Instead, the coup leaders simply evicted Shinawatra allies from the top Thai state companies and replaced them with military cronies or military men themselves, leaving Thai-style state capitalism in place.

Even in freer developing nations, it will prove extremely tough for leaders such as India’s Modi or Indonesia’s new president, Joko Widodo, to roll back state economics. Democratically elected leaders who don’t respond to public opinion usually wind up without publics to lead, and statism remains popular with many segments of the population. India and Indonesia, like other developing nations, were born with statist economics as part of their identity. The statism of Mohandas Gandhi and Sukarno still has some appeal, even if it’s proven woefully ineffective in fostering long-term growth.

Complicating reformers’ jobs is that state capitalism works, up to a point. In some developing nations, governments have used statist strategies to make some industries globally competitive, cut poverty, and create jobs. In Brazil, the government of former President Luiz Inácio Lula da Silva boosted state influence over the economy by increasing the power of the state’s development bank and taking greater control of major companies in oil, gas, mining, and other industries. At the same time he presided over growth, job creation, and a dramatic reduction in the number of poor, winning over millions of Brazilians. Lula’s brand of state intervention, however, couldn’t be sustained; since 2010, Brazil’s gross domestic product growth rate has trended worrisomely downward.

Still, the recent and deep economic slumps in Europe, Japan, and the U.S. haven’t impressed the developing world, leaving many people there skeptical of market-oriented reforms and economic liberalization. In Indonesia, both candidates in the recent presidential race highlighted their commitments to state capitalism throughout their campaigns. Widodo’s opponent in the presidential campaign, former General Prabowo Subianto, vowed that his administration would nationalize investments in natural resources, invest $75 billion in new, state-funded megaprojects similar to China’s giant infrastructure projects, and impose tough regulations on foreign investors who invest in the country. Widodo, popularly known as Jokowi, promised he would reassert state control of some natural resources, launch state plans to make Indonesia self-sufficient in staple foods, and help his compatriots escape the “market forces” that, he said, had trapped Indonesia into dependence on foreign capital.

In India, the appeal of state intervention and worry about Western-style economics also remain significant, despite Modi’s free-market-oriented success running Gujarat state. Indeed, bowing to public concern that he might push painful liberalizations and cut state outlays, Modi hasn’t enacted the major reforms many investors expected when he was elected. Instead, the prime minister has used his mandate to tinker at the edges of India’s economy. Modi’s first budget contained only minor changes from previous governments’ economic policies, keeping in place some $43 billion in state subsidies that are enormously popular among poorer Indians.

The staying power of state capitalism should be a source of concern for Western policymakers. Economic liberalization in the giant emerging markets matters not only for Indians and Chinese and Brazilians but also for the entire world. These huge nations will be the biggest engines of expansion over the next three decades. Standard Chartered bank estimates that about 70 percent of global growth until 2030 will come from emerging markets. Breaking free of the shackles of statism would allow them to grow even faster, to the benefit of the entire world economy, including the U.S.

The growing middle classes in these countries are, after all, increasingly the leading consumers of Western products and will be essential to the continued success of companies in Europe, Japan, and the U.S. as populations in much of the developed world shrink. If these emerging giants slow down drastically, with the state hindering entrepreneurship and running up debt, Western companies—and the world—could face a prolonged slump that would make the last few years look like a mild blip.

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