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Wednesday, June 13, 2007

How state capitalism could change the world

How state capitalism could change the world
By Gerard Lyons
Published: June 7 2007 19:46 Last updated: June 7 2007 19:46

State capitalism and resource nationalism are set to become two of the main economic issues of our time. Across Asia, Russia and the Middle East, governments look set to use their countries’ currency reserves and savings to acquire overseas assets.

The concept of using official savings is not new. The Kuwaiti Investment Office was created after the first oil boom, while in the early 1980s Singapore established its government Investment Corporation, which has presided over a successful investment strategy.

The difference now is that the number of countries pursuing such a strategy has soared, the funds at their disposal are huge and targets are more controversial. China’s $200bn to $300bn strategic investment fund is just the latest example; the potential tensions from this fund were underscored by its $3bn investment in Blackstone Group, the US private equity group.

Not all countries on the receiving end of these flows are receptive to the idea. The Thai authorities
reacted badly to Temasek of Singapore’s purchase of a telecommunications stake in their country. Dubai Ports World had to abandon its attempt to buy P&O’s US ports after it prompted a national security debate in the US Congress. The bid by China’s CNOOC for Unocal was also blocked in the US. There is no reason to expect this hostility to change with the 2008 US presidential elections.
One controversial area is the use of state funds to buy strategic energy assets. The clearest example is China’s courting of commodity producers, especially in Africa. There has been a backlash to this in some African countries, but their concerns may not last long given the need to attract foreign direct investment. How will the market and global trading companies cope with deals between governments on the buying and selling of commodities, or even with official funds buying important stakes in the mining com­panies themselves?

Equally controversial could be specific investment stakes in companies. In the US the fear is of foreign governments acquiring strategic stakes in vital industries. It is easy to see the US blocking future deals, as it did with Dubai Ports. All a US politician needs to ask is: should China be able to secure intellectual property rights overseas, when it cannot guarantee to safeguard such rights for foreign firms in its market? If blocked in the US, one response for state funds may be to opt for more complex, hidden transactions. Equally likely, the money may flow to more open markets, such as London.

While the fear is a protectionist response, the west should use the growth of state capitalism to force positive changes in the investing countries’ home markets. For instance, in the UK’s financial sector the aim will be to continue to embrace the “Wimbledon effect”: better to have London as one of the best financial markets in the world, even if most good players are owned by foreigners. But at Wimbledon the playing field is flat. Chinese banks may buy, own and exert full control over British banks, but could the reverse happen? If the west accepts that Chinese firms can buy freely overseas, this should lead to pressure for China to open its domestic markets further. Similar pressure should be applied to other countries with large state funds that invest overseas.

There will be an impact on market prices. Asian reserves are now $3,300bn, while state-run funds in the Middle East may be $2,000bn. Such funds would not be the main driver of global equity markets, but they could have an impact on US yields. The capitalisation of the three main US equity markets is $22,200bn, while that of US Treasury debt is $4,600bn. A bigger issue arises if these funds start to invest now, at a nascent stage, in the growing equity and debt markets of the future, across Asia, Latin America and Africa. The impact of state funds could be huge in these growing regional markets that are smaller and less liquid.

Yet even in the mature markets there could be consequences if a state fund is a big shareholder in a firm caught in a hostile bid. Would one really want a fund run by the Russian authorities, say, deciding on the fate of a hostile banking takeover in Europe?

At a time of uncertainty for the multi­lateral trading system, this issue of state capitalism is an area where the World Trade Organisation should see whether some ground rules are possible. If not, as globalisation takes hold the three most common words we may read may no longer be “Made in China” but “Owned by China”.

The author is chief economist at Standard Chartered

Copyright The Financial Times Limited 2007
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