State Capitalism 2.0

Alissa Amico *

The collapse of the Soviet Union may not have marked the end of history, but it did inaugurate a "golden age" for laissez-faire economics. And yet, in less than 30 years, the retreat of the state has been reversed, with sovereign owners playing a more active role in corporate governance.

GENEVA – The fall of the Berlin Wall almost 30 years ago represented a high-water mark in the retreat of the state from the global economy, signaling a defeat of socialist economics virtually worldwide. From dirigiste France to communist China, countries with widely divergent economic models began to adopt a more laissez-faire policymaking approach, predicated on the idea that the less state intervention, the better.

Amid this global rollback of statist and socialist economics, some state-owned enterprises (SOEs) were privatized outright. But the vast majority of “crown jewels” remained partly in the hands of governments, with a strategic private partner or private investors acquiring stakes through capital markets. Whatever its form, privatization did not just express a philosophical direction; it also had wide-ranging economic consequences, not least on stock exchanges, which were revitalized through SOE listings in countries as different as Italy and Egypt.

With the turn of the millennium, however, the retreat of the state from the economy stopped in its tracks. The success of economies such as China, which is driving economic development through its SOEs, and the United Arab Emirates, which is driving economic diversification through its sovereign wealth funds (SWFs), has raised potent questions about the efficacy of private-sector-led growth.

A number of governments have sought to replicate China’s experiment with its SOEs and Singapore’s experience with its SWF, Temasek. In the Middle East, for example, a quiet state-driven economic revolution has been unfolding in recent years, epitomized by Dubai’s emergence as the world’s largest hub for international air travel, recently surpassing London’s Heathrow.

While the potential floating of shares of Saudi Aramco, Saudi Arabia’s state-owned oil company, seems to suggest that privatization has not been completely jettisoned, there is a wider and potentially more important trend. Rather than privatizing, governments around the world are increasingly looking for ways to address their SOEs’ perennial weaknesses, including their lagging corporate governance, low productivity, and subpar innovation.

To that end, the structure of sovereign wealth is evolving from a legacy model of passive state ownership to one that recognizes that SOEs’ survival hinges on their ability to compete internationally. An SOE’s monopolistic or oligopolistic position at home no longer ensures its competitiveness, particularly in the context of disruptive new technologies that cross borders. In the long term, government protection will not help a state-owned telecom fend off the likes of Skype, WhatsApp, and Viber.

In response to this challenge, governments are focusing less on privatization than on modernization. Many SOEs and SWFs have recently established venture capital arms to target high-tech companies producing innovation that can underpin their core businesses. Saudi Telecom, for example, has launched STC Ventures to invest the company’s cash as well as pursue opportunities in cutting-edge technologies. Similarly, the Investment Corporation of Dubai, one of the Emirati SWFs, has invested $47 million in Indigo, a Boston-based farming technology start-up.

Still, SOEs and SWFs have limited experience in the tech sector, and their corporate culture is rather rigid compared to the companies they are targeting. Overseeing the governance of high-tech firms requires a fundamentally different skill set than managing joint ventures with foreign partners, a craft that SOEs and SWFs have recently perfected. Hence, to secure the necessary expertise, the Saudi Public Investment Fund has formed a partnership with Japan’s Softbank, and Abu Dhabi’s Mubadala Investment Company has entered into an agreement with the French state-backed investment vehicles CDC International Capital and Bpifrance.

Yet even with the know-how in place, the governance of high-tech companies such as Facebook and Snapchat can pose additional challenges, because both tech company founders and sovereign investors tend to prefer a high level of operational control. Beyond the matter of control, the acquisition of technology companies also requires SOEs and SWFs to take a different approach to risk management, owing to the unstable nature of valuations in this sector.

In this regard, emerging-market sovereign investors have much to learn from China, where SOEs have been actively acquiring technology firms worldwide. Following a few problematic episodes in recent years, China’s finance ministry has now issued guidelines to mitigate the risks for SOEs pursuing foreign acquisitions.

Even if many emerging-market sovereign funds would prefer to remain quiet, non-voting investors with passive stakes in foreign companies, the tech-sector acquisition spree that is currently underway demands that they gain a better understanding of their rights as shareholders. It also requires that they equip their teams with more investment expertise and coordinate closely with other domestic investors so that their acquisitions can have a multiplier effect on their respective national economies.

With private-equity activity having declined in the Middle East and indeed elsewhere in recent years, owing to the fallout from the Abraaj Capital saga, SOEs and SWFs in the region will likely continue to establish their own private equity vehicles. Through sovereign investments in high-tech firms, policymakers can produce positive multiplier effects, including on the capital markets that were previously developed through privatization.

For example, SOEs may be able to list private-equity funds that they establish, while grooming domestic high-tech firms in which they invest for potential listings of their own. This would benefit the local equity markets as much as – or perhaps even more than – the listing of the SOEs themselves, given that exchanges now include specific listing segments geared toward luring innovative firms.

In any case, to focus solely on the privatization of large SOEs is to give a false impression of the direction of state capitalism in emerging markets. State capitalism 2.0 is not premised on the dilution of government ownership, but rather on its realignment with the future of the world economy. This shift is fundamental to the survival of state ownership, and it requires that sovereign investors rethink their traditional governance paradigm. If SOEs are not to go the way of the dinosaurs, they will need to learn not only to waltz with foreign partners, but also to breakdance, fall, get up, and try out new moves. //project-syndicate

* Alissa Amico is Managing Director of GOVERN, the Economic and Corporate Governance Center.