miércoles, noviembre 28, 2018



Part 1

The Land That Failed to Fail

The West was sure the Chinese approach would not work. It just had to wait. It’s still waiting.


     Photographs by BRYAN DENTON 

In the uncertain years after Mao’s death, long before China became an industrial juggernaut, before the Communist Party went on a winning streak that would reshape the world, a group of economics students gathered at a mountain retreat outside Shanghai. There, in the bamboo forests of Moganshan, the young scholars grappled with a pressing question: How could China catch up with the West?

It was the autumn of 1984, and on the other side of the world, Ronald Reagan was promising “morning again in America.” China, meanwhile, was just recovering from decades of political and economic turmoil. There had been progress in the countryside, but more than three-quarters of the population still lived in extreme poverty. The state decided where everyone worked, what every factory made and how much everything cost.

The students and researchers attending the Academic Symposium of Middle-Aged and Young Economists wanted to unleash market forces but worried about crashing the economy — and alarming the party bureaucrats and ideologues who controlled it.

Late one night, they reached a consensus: Factories should meet state quotas but sell anything extra they made at any price they chose. It was a clever, quietly radical proposal to undercut the planned economy — and it intrigued a young party official in the room who had no background in economics. “As they were discussing the problem, I didn’t say anything at all,” recalled Xu Jing’an, now 76 and retired. “I was thinking, how do we make this work?”

The Chinese economy has grown so fast for so long now that it is easy to forget how unlikely its metamorphosis into a global powerhouse was, how much of its ascent was improvised and born of desperation. The proposal that Mr. Xu took from the mountain retreat, soon adopted as government policy, was a pivotal early step in this astounding transformation.

China now leads the world in the number of homeowners, internet users, college graduates and, by some counts, billionaires. Extreme poverty has fallen to less than 1 percent. An isolated, impoverished backwater has evolved into the most significant rival to the United States since the fall of the Soviet Unión.

China today might be unrecognizable to its Communist founders, but the past still holds a powerful allure. “Red tourism” is a big industry. 

It is less worried now about catching up to the West. Instead, it wonders how to pull ahead.

The country leads the world in the number of internet users and college graduates. It is now working to land a person on the moon. 

Gone are the days when the state decided where everyone worked and what every factory made. 

The world thought it would change China, but China’s success has been so spectacular that it has changed the world.

An epochal contest is underway. With President Xi Jinping pushing a more assertive agenda overseas and tightening controls at home, the Trump administration has launched a trade war and is gearing up for what could be a new Cold War. Meanwhile, in Beijing the question these days is less how to catch up with the West than how to pull ahead — and how to do so in a new era of American hostility.

The pattern is familiar to historians, a rising power challenging an established one, with a familiar complication: For decades, the United States encouraged and aided China’s rise, working with its leaders and its people to build the most important economic partnership in the world, one that has lifted both nations.

During this time, eight American presidents assumed, or hoped, that China would eventually bend to what were considered the established rules of modernization: Prosperity would fuel popular demands for political freedom and bring China into the fold of democratic nations. Or the Chinese economy would falter under the weight of authoritarian rule and bureaucratic rot.

But neither happened. Instead, China’s Communist leaders have defied expectations again and again. They embraced capitalism even as they continued to call themselves Marxists. They used repression to maintain power but without stifling entrepreneurship or innovation. Surrounded by foes and rivals, they avoided war, with one brief exception, even as they fanned nationalist sentiment at home. And they presided over 40 years of uninterrupted growth, often with unorthodox policies the textbooks said would fail.

In late September, the People’s Republic of China marked a milestone, surpassing the Soviet Union in longevity. Days later, it celebrated a record 69 years of Communist rule. And China may be just hitting its stride — a new superpower with an economy on track to become not just the world’s largest but, quite soon, the largest by a wide margin.

The world thought it could change China, and in many ways it has. But China’s success has been so spectacular that it has just as often changed the world — and the American understanding of how the world works.

There is no simple explanation for how China’s leaders pulled this off. There was foresight and luck, skill and violent resolve, but perhaps most important was the fear — a sense of crisis among Mao’s successors that they never shook, and that intensified after the Tiananmen Square massacre and the collapse of the Soviet Union.

Even as they put the disasters of Mao’s rule behind them, China’s Communists studied and obsessed over the fate of their old ideological allies in Moscow, determined to learn from their mistakes. They drew two lessons: The party needed to embrace “reform” to survive — but “reform” must never include democratization.

China has veered between these competing impulses ever since, between opening up and clamping down, between experimenting with change and resisting it, always pulling back before going too far in either direction for fear of running aground.

Many people said that the party would fail, that this tension between openness and repression would be too much for a nation as big as China to sustain. But it may be precisely why China soared.

Whether it can continue to do so with the United States trying to stop it is another question entirely.

Apparatchiks Into Capitalists

None of the participants at the Moganshan conference could have predicted how China would take off, much less the roles they would play in the boom ahead. They had come of age in an era of tumult, almost entirely isolated from the rest of the world, with little to prepare them for the challenge they faced. To succeed, the party had to both reinvent its ideology and reprogram its best and brightest to carry it out.

Mr. Xu, for example, had graduated with a degree in journalism on the eve of Mao’s violent Cultural Revolution, during which millions of people were purged, persecuted and killed. He spent those years at a “cadre school” doing manual labor and teaching Marxism in an army unit. After Mao’s death, he was assigned to a state research institute tasked with fixing the economy. His first job was figuring out how to give factories more power to make decisions, a subject he knew almost nothing about. Yet he went on to a distinguished career as an economic policymaker, helping launch China’s first stock market in Shenzhen.

Among the other young participants in Moganshan were Zhou Xiaochuan, who would later lead China’s central bank for 15 years; Lou Jiwei, who ran China’s sovereign wealth fund and recently stepped down as finance minister; and an agricultural policy specialist named Wang Qishan, who rose higher than any of them.

Mr. Wang headed China’s first investment bank and helped steer the nation through the Asian financial crisis. As Beijing’s mayor, he hosted the 2008 Olympics. Then he oversaw the party’s recent high-stakes crackdown on corruption. Now he is China’s vice president, second in authority only to Xi Jinping, the party’s leader.

The careers of these men from Moganshan highlight an important aspect of China’s success: It turned its apparatchiks into capitalists.

Bureaucrats who were once obstacles to growth became engines of growth. Officials devoted to class warfare and price controls began chasing investment and promoting private enterprise. Every day now, the leader of a Chinese district, city or province makes a pitch like the one Yan Chaojun made at a business forum in September.

“Sanya,” Mr. Yan said, referring to the southern resort town he leads, “must be a good butler, nanny, driver and cleaning person for businesses, and welcome investment from foreign companies.”

It was a remarkable act of reinvention, one that eluded the Soviets. In both China and the Soviet Union, vast Stalinist bureaucracies had smothered economic growth, with officials who wielded unchecked power resisting change that threatened their privileges.

Mikhail Gorbachev, the last leader of the Soviet Union, tried to break the hold of these bureaucrats on the economy by opening up the political system. Decades later, Chinese officials still take classes on why that was a mistake. The party even produced a documentary series on the subject in 2006, distributing it on classified DVDs for officials at all levels to watch.

Afraid to open up politically but unwilling to stand still, the party found another way. It moved gradually and followed the pattern of the compromise at Moganshan, which left the planned economy intact while allowing a market economy to flourish and outgrow it.

Once an impoverished backwater, China is now the most significant rival to the United States. Wuhan, a former river town, has swelled into a metropolis of over 10 million.

A businessman stretched before a round of video golf at a hotel he built in Kunming.

       Rising incomes have turned China into a nation of consumers.

        In cities like Shanghai, Chinese schoolchildren outperform peers around the world.

Western economists doubted that innovation could take place under China’s rigid bureaucracy. They were proved wrong.

Party leaders called this go-slow, experimental approach “crossing the river by feeling the stones” — allowing farmers to grow and sell their own crops, for example, while retaining state ownership of the land; lifting investment restrictions in “special economic zones,” while leaving them in place in the rest of the country; or introducing privatization by selling only minority stakes in state firms at first.

“There was resistance,” Mr. Xu said. “Satisfying the reformers and the opposition was an art.”

American economists were skeptical. Market forces needed to be introduced quickly, they argued; otherwise, the bureaucracy would mobilize to block necessary changes. After a visit to China in 1988, the Nobel laureate Milton Friedman called the party’s strategy “an open invitation to corruption and inefficiency.”

But China had a strange advantage in battling bureaucratic resistance. The nation’s long economic boom followed one of the darkest chapters of its history, the Cultural Revolution, which decimated the party apparatus and left it in shambles. In effect, autocratic excess set the stage for Mao’s eventual successor, Deng Xiaoping, to lead the party in a radically more open direction.

That included sending generations of young party officials to the United States and elsewhere to study how modern economies worked. Sometimes they enrolled in universities, sometimes they found jobs, and sometimes they went on brief “study tours.” When they returned, the party promoted their careers and arranged for others to learn from them.

At the same time, the party invested in education, expanding access to schools and universities, and all but eliminating illiteracy. Many critics focus on the weaknesses of the Chinese system — the emphasis on tests and memorization, the political constraints, the discrimination against rural students. But mainland China now produces more graduates in science and engineering every year than the United States, Japan, South Korea and Taiwan combined.

In cities like Shanghai, Chinese schoolchildren outperform peers around the world. For many parents, though, even that is not enough. Because of new wealth, a traditional emphasis on education as a path to social mobility and the state’s hypercompetitive college entrance exam, most students also enroll in after-school tutoring programs — a market worth $125 billion, according to one study, or as much as half the government’s annual military budget.

Another explanation for the party’s transformation lies in bureaucratic mechanics. Analysts sometimes say that China embraced economic reform while resisting political reform. But in reality, the party made changes after Mao’s death that fell short of free elections or independent courts yet were nevertheless significant.

The party introduced term limits and mandatory retirement ages, for example, making it easier to flush out incompetent officials. And it revamped the internal report cards it used to evaluate local leaders for promotions and bonuses, focusing them almost exclusively on concrete economic targets.

These seemingly minor adjustments had an outsize impact, injecting a dose of accountability — and competition — into the political system, said Yuen Yuen Ang, a political scientist at the University of Michigan. “China created a unique hybrid,” she said, “an autocracy with democratic characteristics.”

As the economy flourished, officials with a single-minded focus on growth often ignored widespread pollution, violations of labor standards, and tainted food and medical supplies. They were rewarded with soaring tax revenues and opportunities to enrich their friends, their relatives and themselves. A wave of officials abandoned the state and went into business. Over time, the party elite amassed great wealth, which cemented its support for the privatization of much of the economy it once controlled.

The private sector now produces more than 60 percent of the nation’s economic output, employs over 80 percent of workers in cities and towns, and generates 90 percent of new jobs, a senior official said in a speech last year. As often as not, the bureaucrats stay out of the way.

“I basically don’t see them even once a year,” said James Ni, chairman and founder of Mlily, a mattress manufacturer in eastern China. “I’m creating jobs, generating tax revenue. Why should they bother me?”

In recent years, President Xi has sought to assert the party’s authority inside private firms. He has also bolstered state-owned enterprises with subsidies while preserving barriers to foreign competition. And he has endorsed demands that American companies surrender technology in exchange for market access.

In doing so, he is betting that the Chinese state has changed so much that it should play a leading role in the economy — that it can build and run “national champions” capable of outcompeting the United States for control of the high-tech industries of the future. But he has also provoked a backlash in Washington.

‘Opening Up’

In December, the Communist Party will celebrate the 40th anniversary of the “reform and opening up” policies that transformed China. The triumphant propaganda has already begun, with Mr. Xi putting himself front and center, as if taking a victory lap for the nation.

He is the party’s most powerful leader since Deng and the son of a senior official who served Deng, but even as he wraps himself in Deng’s legacy, Mr. Xi has set himself apart in an important way: Deng encouraged the party to seek help and expertise overseas, but Mr. Xi preaches self-reliance and warns of the threats posed by “hostile foreign forces.”

In other words, he appears to have less use for the “opening up” part of Deng’s slogan.

Of the many risks that the party took in its pursuit of growth, perhaps the biggest was letting in foreign investment, trade and ideas. It was an exceptional gamble by a country once as isolated as North Korea is today, and it paid off in an exceptional way: China tapped into a wave of globalization sweeping the world and emerged as the world’s factory. China’s embrace of the internet, within limits, helped make it a leader in technology. And foreign advice helped China reshape its banks, build a legal system and create modern corporations.

The party prefers a different narrative these days, presenting the economic boom as “grown out of the soil of China” and primarily the result of its leadership. But this obscures one of the great ironies of China’s rise — that Beijing’s former enemies helped make it possible. 

President Xi Jinping has shown no sign of abandoning what he calls “the great rejuvenation of the Chinese nation.” The observation deck of the Shanghai Tower, the world’s second-tallest building.

A Communist Party Congress. Mr. Xi seems to believe that China has been so successful that the party can return to its authoritarian past. 

China tapped into a wave of globalization and emerged as the world’s factory. Advertising for day laborers in Shenzhen.

A fashion design employee at a bridal wear exhibition in Beijing may have taken the opportunity for a break, but no one calls China a sleeping giant anymore.

Installing solar panels on a 47-story residential development. China succeeded by leaving a planned economy intact and allowing a market economy to flourish and outgrow it.

The United States and Japan, both routinely vilified by party propagandists, became major trading partners and were important sources of aid, investment and expertise. The real game changers, though, were people like Tony Lin, a factory manager who made his first trip to the mainland in 1988.

Mr. Lin was born and raised in Taiwan, the self-governing island where those who lost the Chinese civil war fled after the Communist Revolution. As a schoolboy, he was taught that mainland China was the enemy.

But in the late 1980s, the sneaker factory he managed in central Taiwan was having trouble finding workers, and its biggest customer, Nike, suggested moving some production to China. Mr. Lin set aside his fears and made the trip. What he found surprised him: a large and willing work force, and officials so eager for capital and know-how that they offered the use of a state factory free and a five-year break on taxes.

Mr. Lin spent the next decade shuttling to and from southern China, spending months at a time there and returning home only for short breaks to see his wife and children. He built and ran five sneaker factories, including Nike’s largest Chinese supplier.

“China’s policies were tremendous,” he recalled. “They were like a sponge absorbing water, money, technology, everything.”

Mr. Lin was part of a torrent of investment from ethnic Chinese enclaves in Hong Kong, Taiwan, Singapore and beyond that washed over China — and gave it a leg up on other developing countries. Without this diaspora, some economists argue, the mainland’s transformation might have stalled at the level of a country like Indonesia or Mexico.

The timing worked out for China, which opened up just as Taiwan was outgrowing its place in the global manufacturing chain. China benefited from Taiwan’s money, but also its managerial experience, technology and relationships with customers around the world. In effect, Taiwan jump-started capitalism in China and plugged it into the global economy.

Before long, the government in Taiwan began to worry about relying so much on its onetime enemy and tried to shift investment elsewhere. But the mainland was too cheap, too close and, with a common language and heritage, too familiar. Mr. Lin tried opening factories in Thailand, Vietnam and Indonesia but always came back to China.

Now Taiwan finds itself increasingly dependent on a much more powerful China, which is pushing ever harder for unification, and the island’s future is uncertain.

There are echoes of Taiwan’s predicament around the world, where many are having second thoughts about how they rushed to embrace Beijing with trade and investment.

The remorse may be strongest in the United States, which brought China into the World Trade Organization, became China’s largest customer and now accuses it of large-scale theft of technology — what one official called “the greatest transfer of wealth in history.”

Many in Washington predicted that trade would bring political change. It did, but not in China. “Opening up” ended up strengthening the party’s hold on power rather than weakening it. The shock of China’s rise as an export colossus, however, was felt in factory towns around the world.

In the United States, economists say at least two million jobs disappeared as a result, many in districts that ended up voting for President Trump.

Selective Repression

Over lunch at a luxurious private club on the 50th floor of an apartment tower in central Beijing, one of China’s most successful real estate tycoons explained why he had left his job at a government research center after the crackdown on the student-led democracy movement in Tiananmen Square.

“It was very easy,” said Feng Lun, the chairman of Vantone Holdings, which manages a multibillion-dollar portfolio of properties around the world. “One day, I woke up and everyone had run away. So I ran, too.”

Until the soldiers opened fire, he said, he had planned to spend his entire career in the civil service. Instead, as the party was pushing out those who had sympathized with the students, he joined the exodus of officials who started over as entrepreneurs in the 1990s.

“At the time, if you held a meeting and told us to go into business, we wouldn’t have gone,” he recalled. “So this incident, it unintentionally planted seeds in the market economy.”

Such has been the seesaw pattern of the party’s success.

The pro-democracy movement in 1989 was the closest the party ever came to political liberalization after Mao’s death, and the crackdown that followed was the furthest it went in the other direction, toward repression and control. After the massacre, the economy stalled and retrenchment seemed certain. Yet three years later, Deng used a tour of southern China to wrestle the party back to “reform and opening up” once more.

Many who had left the government, like Mr. Feng, suddenly found themselves leading the nation’s transformation from the outside, as its first generation of private entrepreneurs.

Now Mr. Xi is steering the party toward repression again, tightening its grip on society, concentrating power in his own hands and setting himself up to rule for life by abolishing the presidential term limit. Will the party loosen up again, as it did a few years after Tiananmen, or is this a more permanent shift? If it is, what will it mean for the Chinese economic miracle?

The fear is that Mr. Xi is attempting to rewrite the recipe behind China’s rise, replacing selective repression with something more severe.

For decades, China has veered between openness and repression, including of the ethnic Uighur minority. 

Since the Tiananmen movement, the government has been vigilant about crushing potential threats. Surveillance cameras in Beijing. 

China’s high-speed rail network, the largest in the world, has changed the way its people move. In Hangzhou, passengers waited outside the railway station.

As China opened up, farmers were allowed to grow and sell their own crops, while the state retained ownership of the land. Greenhouses filled with bok choy and yellow cabbage abut investment properties and golf courses.

Under Mao, many educated Chinese were sent to “cadre schools,” where they did manual labor. In May, these real estate agency employees went for a morning run as part of a company team-building exercise.

The party has always been vigilant about crushing potential threats — a fledgling opposition party, a popular spiritual movement, even a dissident writer awarded the Nobel Peace Prize. But with some big exceptions, it has also generally retreated from people’s personal lives and given them enough freedom to keep the economy growing.

The internet is an example of how it has benefited by striking a balance. The party let the nation go online with barely an inkling of what that might mean, then reaped the economic benefits while controlling the spread of information that could hurt it.

In 2011, it confronted a crisis. After a high-speed train crash in eastern China, more than 30 million messages criticizing the party’s handling of the fatal accident flooded social media — faster than censors could screen them.

Panicked officials considered shutting down the most popular service, Weibo, the Chinese equivalent of Twitter, but the authorities were afraid of how the public would respond. In the end, they let Weibo stay open but invested much more in tightening controls and ordered companies to do the same.

The compromise worked. Now, many companies assign hundreds of employees to censorship duties — and China has become a giant on the global internet landscape.

“The cost of censorship is quite limited compared to the great value created by the internet,” said Chen Tong, an industry pioneer. “We still get the information we need for economic progress.”

A ‘New Era’

China is not the only country that has squared the demands of authoritarian rule with the needs of free markets. But it has done so for longer, at greater scale and with more convincing results than any other.

The question now is whether it can sustain this model with the United States as an adversary rather than a partner.

The trade war has only just begun. And it is not just a trade war. American warships and planes are challenging Chinese claims to disputed waters with increasing frequency even as China keeps ratcheting up military spending. And Washington is maneuvering to counter Beijing’s growing influence around the world, warning that a Chinese spending spree on global infrastructure comes with strings attached.

The two nations may yet reach some accommodation. But both left and right in America have portrayed China as the champion of an alternative global order, one that embraces autocratic values and undermines fair competition. It is a rare consensus for the United States, which is deeply divided about so much else, including how it has wielded power abroad in recent decades — and how it should do so now.

Mr. Xi, on the other hand, has shown no sign of abandoning what he calls “the great rejuvenation of the Chinese nation.” Some in his corner have been itching to take on the United States since the 2008 financial crisis and see the Trump administration’s policies as proof of what they have always suspected — that America is determined to keep China down.

At the same time, there is also widespread anxiety over the new acrimony, because the United States has long inspired admiration and envy in China, and because of a gnawing sense that the party’s formula for success may be faltering.

Prosperity has brought rising expectations in China; the public wants more than just economic growth. It wants cleaner air, safer food and medicine, better health care and schools, less corruption and greater equality. The party is struggling to deliver, and tweaks to the report cards it uses to measure the performance of officials hardly seem enough.

“The basic problem is, who is growth for?” said Mr. Xu, the retired official who wrote the Moganshan report. “We haven’t solved this problem.”

Growth has begun to slow, which may be better for the economy in the long term but could shake public confidence. The party is investing ever more in censorship to control discussion of the challenges the nation faces: widening inequality, dangerous debt levels, an aging population.

Mr. Xi himself has acknowledged that the party must adapt, declaring that the nation is entering a “new era” requiring new methods. But his prescription has largely been a throwback to repression, including vast internment camps targeting Muslim ethnic minorities. “Opening up” has been replaced by an outward push, with huge loans that critics describe as predatory and other efforts to gain influence — or interfere — in the politics of other countries. At home, experimentation is out while political orthodoxy and discipline are in.

In effect, Mr. Xi seems to believe that China has been so successful that the party can return to a more conventional authoritarian posture — and that to survive and surpass the United States it must.

Certainly, the momentum is still with the party. Over the past four decades, economic growth in China has been 10 times faster than in the United States, and it is still more than twice as fast. The party appears to enjoy broad public support, and many around the world are convinced that Mr. Trump’s America is in retreat while China’s moment is just beginning.

Then again, China has a way of defying expectations.

Philip P. Pan is The Times’s Asia Editor and author of “Out of Mao’s Shadow: The Struggle for the Soul of a New China.” He has lived in and reported on China for nearly two decades.

Jonathan Ansfield and Keith Bradsher contributed reporting from Beijing. Claire Fu, Zoe Mou and Iris Zhao contributed research from Beijing, and Carolyn Zhang from Shanghai.

Design: Matt Ruby, Rumsey Taylor, Quoctrung Bui Editing: Tess Felder, Eric Nagourney, David Schmidt Photo Editing: Craig Allen, Meghan Petersen, Mikko Takkunen Illustrations: Sergio Peçanha


Across the West powerful firms are becoming even more powerful

That could undermine public faith in capitalism, says Patrick Foulis
The mobile signal was transmitted on one of the three networks that control 78% of the telecoms market. The flight was with one of the four airlines that control 69% of journeys within America. In Chicago your correspondent checked into the LondonHouse hotel, which looks like a boutique but turns out to be part of Hilton, which controls 12% of all rooms in America, and 25% of the new rooms being built. The booking was made on Expedia, which has 27% of the North American online travel market.
The firms involved in the journey made profits of $151bn and had a median return on capital of 29% last year. An equally weighted basket of their shares—call it the monopoly money portfolio—beat global stockmarkets by 484% over the past decade. Collectively, 17% of the companies’ shares are owned by just three investment mega-managers, BlackRock, Vanguard and State Street.

Described this way, America’s economy has become a capitalist dystopia; a system of extraction by entrenched giants. Europe shows signs of the same sickness. Growing protectionism and increased digitisation may make things worse. The stakes are high.

Competition is an elixir. It spreads wealth today by lowering consumer prices and giving workers more choice of jobs, reducing firms’ monopsony power over them. It boosts productivity tomorrow by pushing firms to create better products for less. If profits in America fell to historically normal levels thanks to more competition, and private-sector workers got the benefits, real wages would rise by 6%. If competition also revived productivity growth, wages could rise a lot further. Without competition, capitalism is torpid and favours the few, not the many.
This special report will examine the claim that big firms are too powerful and that they are stifling competition. It will look at Europe and America, arguing that competition has faded and that a carefully calibrated response is needed. Next, it will consider the tech sector—simultaneously a source of dynamism and monopoly power. Finally it will examine the intellectual decay of the antitrust establishment and explain why inaction is dangerous.

A wake-up call

The view that competition might be in peril extends beyond those travelling from New York to Chicago. It feeds into the public’s sense that the economy is rigged. Pension funds are making huge bets that the likes of Facebook and Hilton can crank out vast profits in perpetuity. Economists worry that powerful firms could distort interest rates; central-bank bosses debated this in August at their gathering at Jackson Hole. In Europe regulators are angry with Silicon Valley. America’s antitrust agencies are waking up from a decades-long slumber, rather like financial regulators after the shock of 2008. Into the vacuum has stepped a radical new antitrust movement that believes the ideal economy is made up of lots of smaller firms with fragmented economic power. It wants to smash concentrations of capital in the name of liberty.

But the story is more complex than big business unfairly crushing all before it. Powerful firms are often efficient and pass the gains to consumers; think of Walmart selling mountains of baked beans for peanuts. They are often innovative, too. Netflix is burning cash to entertain 130m binge watchers. Populists often claim that the West has been ravaged by Chinese competition and is full of lazy incumbents, but can both be true? If monopolies are causing prices to rise, why is inflation low? Go back to that journey to Chicago. Your correspondent chose to switch from Samsung to Apple. The breakfast was cheap. Three of America’s four big airlines have spent time in Chapter 11 protection from creditors since 2005, while its three biggest telecoms firms invest $45bn a year. Expedia’s margins are falling. It is hard to prove that big investors collude. And the LondonHouse is elegant and keenly priced.

“Competition is for losers,” writes Peter Thiel, an American venture capitalist, in his book, “Zero to One”. Monopoly is the goal, he says. But society benefits if successful entrepreneurs are constantly toppled by others. The levelling effect of competition means a constant struggle with vested interests that has played out for hundreds of years.

Adam Smith, a Scottish economist, attacked the guilds that stifled 18th-century Britain. As America boomed in the 19th century industrial empires were created that trustbusters later broke up. Cartels were instrumental in 20th-century totalitarianism. In 1946 American administrators dissolved Japan’s zaibatsu (large industrial and banking conglomerates), and Germany’s Christian Democrats made competition their first priority in their economic manifesto in 1949. Margaret Thatcher used competition to revive Britain’s economy in the 1980s. In the 1990s the European Union used the single market to prise open stuffy industries.

But after 2000 the West became complacent. Globalisation was assumed to guarantee competition. Over-mighty firms were judged to be a risk for corrupt emerging countries like Russia and the Philippines but not the rich world.

In fact powerful firms were gaining more clout in the West, for bad and good reasons. The bad reasons involve muffling competition. Some $44trn of takeovers have taken place since 1998, many aimed at creating pricing power or efficiency gains whose benefits are not passed to consumers. It has become fashionable for managers to build “moats”, or barriers to entry. That is reflected in the philosophy of Warren Buffett, who has built the world’s most valuable investment vehicle by betting on mature oligopolies in America. Clever firms found new ways to constrict competition. A fifth of all American workers are covered by non-compete clauses.

Patents are “evergreened”. Arbitration clauses and complex contracts are used to hobble competitors. A few fund managers own big chunks of most firms. They do not conspire but they do set the tone at the top, doing little to encourage price wars.

The good reason for more powerful firms is the rise of an innovative elite that is an engine of efficiency. Its members are companies that have mastered digital technologies and enjoy network effects that help them fend off slower competitors, says John Van Reenen of MIT. In the tech sector this is clear. In old-fashioned industries, however, particularly regulated ones, digital wizardry is less likely to explain powerful firms’ clout. Whether they were created by cronyism or genius, if extraordinary profits are maintained for many years with no sign of new entrants, it is a clue that competition may not be working. In America and Europe there is a growing body of evidence that this is the case.

Sources and acknowledgements are listed here

The End of the Euro Is Closer Than You Think

By Avi Tiomkin 
The End of the Euro Is Closer Than You Think
Photo Illustration by Nicole Fara Silver 

Europe has always been a disunited continent, with broad ethnic, cultural, linguistic, political, and economic divides. Given these disparities, the imposition of a single currency on a population that now totals 340 million people arguably has been doomed from the start.

A day of reckoning for the euro was postponed in 2012, when European Central Bank President Mario Draghi said the that European Central Bank would do “whatever it takes”—a mandate that came to include massive monetary stimulus to preserve the common currency.  
But the ECB’s desperate actions, which have led to Italy’s current budget showdown with the European Union, could finally result in the euro’s demise.

Prior to the euro-zone crisis of 2011-12, caused by the inability of several member states to refinance their debts and bail out their troubled banks, it was hard to imagine that Europe’s political and bureaucratic leadership would sacrifice all monetary principles and adopt draconian fiscal austerity policies that inflicted irreversible damage on a large swath of the region’s population. Indeed, Draghi’s July 2012 statement—which reportedly was thought by U.S. Treasury Secretary Timothy Geithner and others to have been an impromptu utterance—seemed at the time to have stemmed the crisis.

More likely, it was the launch of an expansive quantitative-easing policy by the U.S. Federal Reserve that precipitated what looked to be a positive change of course in Europe. Within a short period of time, in 2012, the Fed purchased about $1 trillion of financial assets, with the Bank of Japan following suit on a similar scale.

Yet, Europe’s troubles never really abated. By 2015, the euro zone was again engulfed in crisis, with the focus primarily on Greece, whose banking system was in peril. Only then did the ECB undertake an expansive asset-buying program of its own, spending about 80 billion euros ($90 billion) per month. The ECB’s campaign (which is ending this year) infused the European economy with a total of €2.5 trillion over three years, and drove interest rates down to a negative 0.4%.

Draghi was hailed in the past few years as the man who saved Europe. But the monetary policy and austerity imposed on most Europeans proved disastrous, resulting in socio-political turmoil and severe levels of economic inequality. The euro, it turned out, was the problem, not the solution.

It is no coincidence, given the ECB’s medicine, that Marine Le Pen received 34% of the votes in the most recent French presidential election, and that her ultranationalist party is leading President Macron’s party in polls ahead of elections for the European Parliament. Italy is currently led by a right-wing coalition composed of the Northern League and the populist Five Star Movement, or M5S.

Even in Germany, the far-right Alternative for Germany and the left-wing Green party scored major gains in recent state elections. Chancellor Angela Merkel has announced that she won’t run again in December for her Christian Democratic Union’s party leadership, and won’t seek re-election as chancellor.

Meanwhile, the Target2 mechanism funding the euro zone’s deficiencies is wholly sustained by the German financial system, which, together with the Netherlands, Luxemburg, and Finland, coughed up more than €1 trillion for beneficiaries including Italy, Spain, and, to a lesser extent, France. In retrospect, the ECB’s quantitative easing merely substituted for a long-term solution.

Against this background, it is now important to watch Italy closely. The European Commission has demanded that Italy’s new government, which has vowed to end the country’s economic malaise, revise its budget, curbing spending and shrinking the deficit. But unlike Greece, Italy isn’t a pushover.

Matteo Salvini, leader of the Northern League, has labeled Jean-Claude Juncker, president of the European Commission, an “enemy of Europe,” and called the euro “Germany’s currency,” adding that it “was, is, and will remain a mistake.”

Many hope that the current standoff will be resolved by an expansive budgetary policy that is in effect throughout the euro zone. Even if Germany and its satellites agree to implement such a policy, however, which is doubtful, it will have to be on a scale that is likely to cause an inflationary burst, currency destabilization, capital flight, and a dramatic increase in long-term interest rates.

The European Commission has shown little flexibility in its negotiations over Brexit, effectively aiming to punish the United Kingdom for its decision to leave the European Union. In this, Brussels (which is the the de facto capital of the EU) has Italy in mind.

The most plausible solution to the latest impasse appears to be “Italexit”—Italy’s secession from the euro zone. The numerous denials from leaders that this idea “is not under consideration and no such option exists” suggest, instead, that it is.

Given the size of Italy’s economy, such an exit would precipitate the dissolution of the euro zone itself. As Salvini, perceived to be Italy’s de-facto leader, recently said about the euro, “Only death is irreversible.”

Avi Tiomkin is an adviser to hedge funds. He previously managed money for several large hedge funds and specializes in global macroeconomic analysis.

Goldman Wakes Up to 1MDB Reckoning

Shareholders are realizing that the fallout from the 1MDB scandal could be severe for Goldman Sachs

By Aaron Back

Goldman Chief Executive David Solomon said he was “personally outraged” at the conduct of some Goldman employees.
Goldman Chief Executive David Solomon said he was “personally outraged” at the conduct of some Goldman employees. Photo: david gray/Reuters

For the first time, investors are punishing Goldman Sachs GS -0.80%▲ for its role in one of the biggest financial scandals in history. They are right be concerned.

Goldman shares are down around 11% since news broke on Nov. 1 that a former partner pleaded guilty and another former Goldman employee was charged with helping steal money from a Malaysian government investment fund known as 1MDB and paying bribes to the country’s leader to help Goldman win more business. Another partner was cited in an indictment as an unnamed co-conspirator in the global scandal in which funds were looted from the fund through a network of dozens of banks and intermediaries in Asia, Europe and the Middle East. The employee charged couldn't be reached for comment.

In a letter to employees on Thursday, Goldman Chief Executive David Solomon said he was “personally outraged” at the conduct of the Goldman employees, and that they “violated the firm’s policies and procedures, and acted in conflict with all that we stand for.”

It is possible to make informed estimates of the ultimate cost to Goldman. Indeed, the firm’s shareholders have no choice but to start doing so.

The three implicated employees appear to have purposely misled the firm, but Goldman’s internal controls should have prevented that from happening. Goldman could face penalties for missing red flags and for the bribes paid by at least one of its employees.

In a note, Keefe, Bruyette & Woods analyst Brian Kleinhanzl cited four prior cases of big bank fines that he thinks are comparable.

HSBC was fined $1.9 billion by U.S. authorities in 2012 for failing to implement anti-money-laundering controls against drug cartels and sanctioned nations. The same year, Standard Chartered paid an initial fine to the U.S. of $667 million to settle allegations of sanctions breaches, including with Iranian companies. Both banks reached deferred prosecution agreements with the U.S. government.

By contrast BNP Paribasitself plead guilty to crimes for violating sanctions in 2014, and was fined a much higher $8.9 billion.

While every case is different, these precedents suggest a range of $1 billion to $2 billion is a reasonable expectation for Goldman’s potential penalties, according to Mr. Kleinhanzl. The firm already is under pressure from Malaysia’s new government to pay back the roughly $600 million of fees it earned from 1MDB.

Longer term, the reputational harm to Goldman may result in fewer mandates for business in Southeast Asia and from emerging-market sovereign and semi-sovereign issuers world-wide. Wells Fargo ’slong regulatory travails show how getting on U.S. regulators’ bad side can result in years of compliance headaches.

While none of this will be disastrous for Goldman, its share performance nonetheless is likely to lag peers until the ultimate costs become clear.

Goldman shares are still not cheap at around 1 times book value, compared to 1.09 times for rival Morgan Stanley. Investors should wait for further declines before going bargain hunting.

Russia and Ukraine Spar Over the Kerch Strait

The main issue here is Ukrainian fragility, not Russian aggression.

By Jacob L. Shapiro

Russia forcibly blocked three Ukrainian naval vessels from crossing the Kerch Strait into the Sea of Azov on Sunday. Both countries are blaming each other for the incident: Ukraine accuses Russia of blocking its access to the sea, while Russia accuses Ukraine of illegally entering its territorial waters. (The Kerch Strait lies off the eastern tip of Russia-controlled Crimea.) Whatever the case, the Ukrainian ships have been seized and at least three Ukrainian sailors were injured in the incident. Russia temporarily cut off access to the Kerch Strait (it has since been restored) and called an emergency meeting of the U.N. Security Council for later today.

Comparisons to the 2008 Russo-Georgian War, in which Russia used Georgian provocations to justify military action in Georgia, are hard to avoid. The reality, however, is more complicated than this. True, Russia has been slowly solidifying its position in Crimea since March 2014 and appears to be preparing for potential (perhaps inevitable) military intervention in eastern Ukraine. But it’s unlikely that Russia is spoiling for a fight right now.

Indeed, developments in Ukraine had been proceeding in a direction favorable to Russian interests. Ukraine’s economy is struggling, and Kiev had to seek a new standby arrangement with the International Monetary Fund in September to help meet its rising debt payments. Its navy is overmatched and just lost three more ships in the recent dust-up. Presidential elections are slated for March, and polls suggest no candidate has more than 30 percent support – it’s entirely possible that a more pro-Russian government could come to power without Moscow lifting a finger. Meanwhile, Russian President Vladimir Putin is scheduled to meet with U.S. President Donald Trump at the G-20 summit – the latest in a string of Russian attempts to improve relations or at least reduce U.S. sanctions.

Ukraine, on the other hand, has more reason to provoke a conflict. The primary reason is to persuade its European and American allies to continue, and perhaps increase, their support of the government in Kiev, especially as the cost of that support rises. Domestic politics might also play a role. Ukrainian President Petro Poroshenko has said he will ask parliament to declare a state of martial law later today – which could delay the upcoming election in which Poroshenko’s support appears to be dropping. Ukraine has been through far worse in recent years than the Kerch Strait incident without having to invoke martial law.

The conflict in Ukraine is one of the main sticking points in U.S.-Russia relations – it might even be the top sticking point, as evidenced by Washington’s decision to provide Kiev with anti-tank missiles and other lethal weapons late last year. Russia views Ukraine as part of its sphere of influence, while the U.S. recognizes no such sphere. Aside from Belarus, which is practically a Russian province for now, and Moldova, which currently has a pro-Russia president, there is no other weak point in Eastern Europe. The Baltic states, Poland and Romania are NATO members and have iron-clad security guarantees. NATO is also making inroads in the Balkans.

Ukraine, therefore, is the front line in the dispute between Russia and the West over Eastern Europe, and for all of the West’s posturing and rhetoric, Russia is more prepared for conflict there than the West is.

But Russia doesn’t need to push the issue right now. It has lost a great deal of influence in western Ukraine and Kiev, but in eastern Ukraine, cultural, economic and linguistic ties still run deep – and get deeper the farther east you go. In addition, Ukraine is under pressure from not just Russia but also Poland and Hungary, which both have ongoing diplomatic disputes with Kiev. Russia seems more poised for a potential disintegration of the political status quo in Ukraine than an offensive takeover of the country – a takeover that even Russia’s considerable military force couldn’t maintain in western Ukraine. The main issue here is Ukrainian fragility, not Russian aggression, and the Kerch Strait incident shines a light on that fragility more than anything else.

The Islamic State's Fading Territory

The Islamic State’s territory in Syria and Iraq is a shadow of its former self.

By GPF Staff        

In June 2014, a man named Abu Bakr al-Baghdadi, dressed entirely in black, stood at the pulpit in the Great Mosque of al-Nuri in the Iraqi city of Mosul. The mosque he chose was deliberate: It was built in the 12th century by a Turkic ruler famous for fighting Christian crusaders. The name he chose was deliberate: It was a nod to the first caliph, Abu Bakr. The garb he chose was deliberate: It harkened back to the caliphs of yore and the Prophet Muhammad himself. The words he chose were deliberate: Failure to re-establish the caliphate, he said, was nothing less than apostasy. 
And so it was, with reverence and humility, that this shadowy figure, having declared an end to Islam’s humiliation and disgrace, resurrected an Islamic State. In al-Baghdadi’s own words, the “sun of jihad” had risen again.
For over three years, al-Baghdadi’s followers did everything their caliph asked. The group they constituted, known as the Islamic State, conquered towns and cities, set up legal systems based on fundamentalist interpretations of Islamic law, levied and collected taxes, issued currency, provided social services, and attracted adherents from around the world. It fielded highly motivated soldiers who were as adept at tactical maneuvering as they were at strategic planning. Eventually, the group posed such a threat to the established order that traditional enemies became allies, and together they turned the tide of war against the Islamic State, which retreated from its capital city of Raqqa in October 2017.
As a territorial entity, the Islamic State fell as quickly as it rose. Except for a few pockets in the deserts of eastern Syria and western Iraq, it was virtually landless by 2018. Yet as a movement, the Islamic State endures. Its adherents believe it is a legitimate caliphate, and religious beliefs are not circumscribed by physical borders. Shortly before his death in a drone strike in 2016, senior Islamic State leader Abu Mohammed al-Adnani said, “Whoever thinks that we fight to protect some land … has strayed far from the truth.” The Islamic State has conceded Raqqa. It has not conceded defeat.