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Management, Marketing. Financial Markets. Banks and Banking. Saving

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Some small businesses are already using social networks to generate new ideas. After spending time on Twitter, employees at Cordarounds.com, a small American clothing company, noticed that many folk twittering in their area were using bicycles to get to work.

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2015-02-27

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CONTENTS

Part I. Business and Businesses. Management, Marketing.

1. A peach of an opportunity

2. The click and the dead

3. Profiting from friendship

4. Detroitosaurus wrecks

5. An offer you can't refuse*

6. Marriages made in hell

7. The Walmart of the web

8. Big and clever

9. Asia's new model company

10. The rise of state capitalism

Part II. Financial Markets. Banks and Banking. Saving.

11. ... Coming soon!

Part I. Business and Businesses.

Management, Marketing.

1. A peach of an opportunity

Task:

1. Read the article.

2. Make a précis and an annotation of the article.

Small businesses are using networks to become bigger

“HEY first peaches of the season are here. Come and get your peach pie @10am.” Simple tweets like that have helped Mission Pie, a small shop in San Francisco, drum up interest in its mouth-watering of sweet and savoury pies. As well as twittering about its wares, the store also alerts customers to poetry readings and other events it organises. Krystin Rubin, a co-owner of Mission Pie, says the business had just 150 or so followers for a while after one of its bakers started sending out tweets almost a year ago. Then that number suddenly shot up to over 1,000. Over the past few months business has been very brisk and Ms Rubin reckons Twitter deserves part of the credit. “It has a sort of street credibility that’s not there with traditional media,” she says.

Other companies have discovered the same thing. Kogi BBQ, which has several trucks serving Korean food in Los Angeles, now has over 52,000 followers on Twitter and uses the service to tell customers where they can find its vans each day. Sprinkles, a cupcake bakery with stores all over America and nearly 94,000 fans of its Facebook page, posts a password to that page each day which can be redeemed for a free cake by a certain number of visitors to its shops.

Such offers can attract a lot of attention. A survey of 1,000 heavy users of social networks and other digital media conducted a few years ago by Razorfish, an advertising agency, found that 44% of those following brands on Twitter said they did so because of the exclusive deals the firms offered to users.

As Kogi BBQ and Sprinkles show, social networks are arguably having an even greater impact on small businesses than on the big league. By giving entrepreneurs free access to their audience, services such as Twitter and Facebook are putting corporate tiddlers on a par with behemoths such as Starbucks and Dell when it comes to broadcasting messages to a mass market. They have also created what Steve Hasker of Nielsen calls “the world’s biggest, fastest and most dynamic focus groups”, which can be a boon to entrepreneurs without fat research budgets.

Some small businesses are already using social networks to generate new ideas. After spending time on Twitter, employees at Cordarounds.com, a small American clothing company, noticed that many folk twittering in their area were using bicycles to get to work. So the firm produced a new line of trousers, dubbed “bike-to-work pants”, with built-in reflective materials that make wearers more visible to traffic while cycling at night. And of course it used tweets to get the word out about its new creations.

“Follow me on Twitter” signs are appearing on the doors and windows of small businesses in other countries too. A survey last year by O2, a mobile-phone operator, found that some 17% of Britain’s small businesses were using Twitter. Many of the firms that responded said they were doing this to attract new customers. Some reckoned they had been able to save up to £5,000 (over $8,000) a year by cutting out other forms of marketing in favour of the networking service.

Charging for batteries

The connections made possible by social networks are helping to create new businesses as well as promote existing ones. When Henk van Ess, a Dutch technology consultant, posted a complaint about the short lifespan of his iPhone’s battery on LinkedIn a couple of years ago, one respondent suggested that he contact China BAK Battery, which produces a small, plug-in battery for the iPhone. Impressed with the product, Mr Van Ess told members of his online network about it and was soon handling orders for them. After a while he formed his own company, 3GJUICE, to produce a plug-in unit for the iPhone that incorporates the Chinese firm’s battery.

Mr Van Ess’s firm is tiny, but social networks such as Facebook and MySpace have also served as launching pads for much bigger outfits. Among the largest of these are companies such as Zynga, Playfish and Playdom, whose popular online games run on the big networks’ platforms. Some of these games, such as Zynga’s “FarmVille”, have attracted millions of players and produced mountains of money for their creators. Zynga says it has been profitable almost since it opened in 2007, and last month the business attracted an investment of $180m from a bunch of prominent financiers convinced of its potential. Many of the social-games companies are on a hiring binge, creating hundreds of new jobs at a time when the economy around them is in the doldrums. Their experience provides an insight into how social networks can help propel small businesses to much bigger things.

Like most games, the ones produced by Zynga and its peers appeal to people’s natural competitive instincts. Leader boards and a host of other features allow players to show off their status within a game to their friends. But the games also encourage lots of co-operation among players, who can build rapport by, say, sending virtual gifts to each other or handing virtual currency to new players when they join a game. “The best virtual goods have real currency,” says Mark Pincus, Zynga’s boss. He reckons that the games have become so popular because they combine fun with the various ways to strengthen relationships that Facebook and other networks have brought online.

Better than the real thing

Social games have also become extraordinarily popular because they cleverly exploit those relationships. Once someone has signed up for, say, “Mafia Wars”, another Zynga invention, they are urged to invite their friends to join too. And players’ gruesome successes in such games are regularly posted to their personal page on Facebook, which can be seen by all of their friends. Thanks to such wheezes, online games benefit from a powerful network effect. “Café World”, which gives users the opportunity to run their own virtual restaurant, launched on Facebook at the end of September and within a week had attracted a mind-boggling 10m players.

This astonishing growth has been helped by the fact that social games are free to play. The companies make their money by selling digital goods in the games, by carrying advertising and by getting players to sign up for marketing promotions. Surprising though this may seem to some, virtual goods such as swords, tractors and even digital boyfriends are much in demand. After users of its “Sorority Life” game complained in an online forum that the game lacked virtual men they could date, Playdom quickly introduced some last November. Over 10m of the boyfriends were promptly snapped up, with a few players buying as many as 500 each. Some paid for their digital darlings with virtual credits won in the game, but others stumped up over $5 a time for their beaux.

The rise of the social-gaming firms has not been without controversy. Last year Zynga came under fire from TechCrunch, a Silicon Valley blog, for allowing misleading marketing offers to run on its site. The firm subsequently removed them. But such hiccups have not dented interest in social gaming: last November Playfish was snapped up by Electronic Arts, a big video-game publisher that thinks the business is going to be huge. It may well be right. ThinkEquity, an investment bank, reckons that revenues in America from social games can soar in the near future.

Admittedly this is an extreme example of the benefits social networks can bring to small businesses. Rewards for outfits such as Mission Pie will be far more modest. But if they were added up across an entire economy, they could have a significant effect on growth. What a pity, then, that many small firms are reluctant to take the plunge into the social-networking world. A survey of 500 small businesses in America conducted by Citibank last October found that most of them had not used online networks at all because they thought they would be a waste of time.

From The Economist

2. The click and the dead

Task:

1. Read the article.

2. Make a précis and an annotation of the article.

E-commerce favours large companies but only because that is what people want

FOR as long as anyone can recall, chess enthusiasts in Cambridge, Massachusetts, have played on large streetside chessboards in the shadows of the stately buildings of Harvard Yard. But even in a place that seems impervious to the passage of time, there is change. One example is an empty space where a much-loved local institution, an independent bookshop called WordsWorth, stood for 30 years. Like small-business owners in other industries, its proprietors held the internet, of which the student-heavy populace of Cambridge were early adopters, responsible for having to shut up shop in 2004.

Everywhere people bemoan the replacement of the local and the quaint by outposts of big, homogeneous chains. But how true is the notion that the internet in particular has hastened the demise of some retailers, and that those it hurt were overwhelmingly small? A study2 on this subject by four economists at the University of Chicago looks at three industries—bookshops, travel agencies and new-car dealerships—for answers. They find much truth in the conventional wisdom, but also some solace for those who believe small is beautiful.

In the past economists have paid most attention to the effects of the internet on prices. These fit snugly into a standard economic model of competition. The internet acts mainly as a mechanism that reduces consumers’ costs of acquiring information about products and prices. Before the online age, someone looking to buy a fridge, say, might have gone into one or two local shops, and perhaps rung a few more, to compare prices. The web, however, made it easy to gather more information. Theory suggested that as more and more retailers and customers went online, customers would become pickier. It would become more difficult for a retailer to continue to sell overpriced goods because people would have more knowledge about other options.

E-commerce ought therefore to lead to intensified price competition and through it to lower variation, or “dispersion”, in prices. A large scholarly literature has found that this is true. For a real-world example of the effect of lower search costs, think of today’s e-reader price wars. When Barnes & Noble, a bookseller, dropped the price of its Nook e-reader to $199 in America, Amazon responded within hours and cut the price of its Kindle product to $189.

The new study tests another expected consequence of e-commerce. Intensifying competition should lead not just to price convergence but also to a round of creative destruction. Companies that are unable to cope with the demands of consumers in the internet age should be wiped out. Those who can, ought to thrive. Efficient firms should enter the market. Using data on internet usage from a representative survey of Americans, as well as data on the size of firms in each of the three industries in each county in the continental United States, the Chicago economists are able to tease out the impact of the internet on firms in the ten years to 2004, when online shopping first gained a foothold in American life. They can also see whether the effects were larger where more people went online, as one might expect if internet use were the main driver of change.

In all three cases the growth of internet traffic and online shopping affected the structure of the industry, not just prices. In general larger firms grew at the expense of smaller ones. Much as the owners of WordsWorth had surmised, the effect was greatest where online shopping became most popular. The shakeout in travel agencies was particularly vicious. After years of holding steady, the total number of agencies fell precipitously, almost exactly mirroring the growth of online shopping. Within the industry large agencies gained at the expense of smaller ones. In the ten years to 2003 the number of travel agencies that employed more than 100 people grew by 60%, from 109 to 174, and the number of tiny ones fell by a third, from 18,186 to 12,865.

What of the effect on jobs? Officially overall employment in the travel-agency and bookshop industries fell as a result of e-commerce. In fact, some of the slack will have been made up by the growth of online-only companies such as Amazon and Orbitz. But it is impossible to tell how much of the employment growth at these kinds of firms relates to a particular industry. The car-dealership industry, where online-only retailing was prohibited by law, did not lose jobs. Evidence from other studies suggests that customers gathered more quotes than before and got lower prices, but did not buy fewer cars. The same is probably true of books and airline tickets.

Niche work if you can get it

Big firms are not predestined to hoover up all the benefits from e-commerce. The theory suggests that as people become better informed thanks to the web, the businesses that cater most to their desires will thrive. If people want lower prices, then bigger shops and chains, with their economies of scale, may be the ones that do best. But it is equally possible that a small shop meeting a very specific need might see its market share expand because more people who want what it provides (cult records or fan fiction, for instance) learn of its existence.

The study finds evidence for this, too. Among booksellers, all the smaller categories withered in the internet age—save one. The lone exception was the very smallest, shops with between one and four employees. These appeared to have weathered the storm unscathed: in Harvard Square itself, Curious George, a children’s bookshop run by the same people who owned WordsWorth, flourishes to this day. The internet allows customers to see businesses’ true colours. The adjustment that follows may be wrenching. But the net effect is one that conforms to what consumers want, whether they admit it to themselves or not.

From The Economist

3. Profiting from friendship

Task:

1. Read the article.

2. Make a précis and an annotation of the article.

Social networks have a better chance of making money than their critics think

ENTREPRENEURS in Silicon Valley, only half-jokingly, call it the URL strategy. The three letters usually stand for Uniform Resource Locator—the unique address of any file that is accessible via the internet. But in the world of internet start-ups, URL has another meaning: Ubiquity first, Revenue Later. This pretty much describes the strategy of most big online social networks, which over the past few years have concentrated on piling on users rather than worrying about profits. That has allowed them to build huge followings, but it has also raised a big question-mark over their ability to make money from the audiences they have put together.

At issue is whether the social-networking industry can come up with a wildly successful form of advertising that propels it to stardom in the same way that Google has been able to make billions of dollars from the targeted ads that run alongside the search results it serves up. Without such a formula, runs the argument, social networks such as Facebook will never amount to much.

Doubters claim that the networks face two big handicaps. The first is that people logged into social-networking sites are there to hang out with their friends, so they will pay no attention to ads. The second is that because the sites let users generate their own content, they will find it hard to attract advertisers because brands will not want to take the risk of appearing alongside examples of profanity, obscenity or nudity—or all three at once.

Elusive click-throughs

The sceptics have some evidence on their side. Click-through rates on display ads at sites such as Facebook are a small fraction of those that Google commands for its highly targeted search ads. And although marketers love to promote their brands via their own (free) pages on social sites, some are wary of buying ads on them because of those abysmal click-through rates. “We spend the majority of our time engaging with people on these networks, not advertising on them,” says Scott Monty, the head of Ford’s social-media activities. Although user numbers were sharply up last year, the social-networking industry’s revenues in America, its biggest advertising market, rose only by a modest 4% to $1.2 billion, says eMarketer, a market-research firm. That was still an achievement, because the total online advertising market shrank in 2009.

The broader outlook for networking sites is quite encouraging. This year eMarketer expects revenues to grow by over 7%. ComScore, another market-research firm, has found that one in five display ads viewed by American web users last June ran on social-networking sites, with MySpace accounting for the biggest chunk of the total. Another study in Britain last August came up with a similar proportion, with telecoms companies and retailers providing a big chunk of the business.

Why are the networks becoming more popular when their click-through rates are so low? One reason is that advertisers are being drawn to the leading sites by their sheer scale. “Facebook’s audience is bigger than any TV network that has ever existed on the face of the earth,” says Randall Rothenberg, the head of the Interactive Advertising Bureau (IAB). Another thing that has attracted companies is the networks’ ability to target ads with laser-like precision, thanks to the data they hold on their users’ ages, gender, interests and so forth. Although there are still lingering concerns about brands appearing next to racy content, firms seem more willing to run this risk now that the networks’ advertising proposition has become more compelling.

The other reason more money is heading the networks’ way is that some advertisers are seeing a great return on their investment. Michael Lynton, the boss of Sony Pictures Entertainment, a film studio, says he was deeply sceptical about using social-networking sites for advertising. Indeed, Mr Lynton is famous for having once declared that nothing good had ever come from the internet, which was a jab at online piracy of film studios’ content.

But something good did come from an online experiment that Sony conducted last summer. The studio ran a series of ads on Facebook promoting three of its films after they had just featured in a traditional television campaign. “District 9” was aimed at young men, “Julie & Julia” at middle-aged women and “The Ugly Truth” at younger women. Awareness of the films was measured after the TV ads had run and then again after the web ads had run. Each time the online ads significantly boosted awareness. Mr Lynton says he is now convinced that social networks are radically altering the marketing landscape.

Rock, baby

Another firm that has become convinced of that is Toyota, which last year worked with MySpace to create a competition called “Rock the Space” in which bands were invited to send in demo tapes of their music. Some 18,000 entries were received and MySpace’s users voted for the best tape, with a record contract as the prize for the winning band. Doug Frisbie, who oversees social-media marketing for Toyota’s American operations, says the promotion exceeded the company’s hopes for brand promotion “by a factor of several times.”

Both firms’ experience suggests that people using social networks are more likely to engage with brands than sceptics think. Mr Lynton also reckons that the networks produce a powerful viral marketing effect because friends use them to tell one another about things they have discovered. Marketers have long known that such recommendations are hugely important in purchase decisions. Social networks are harnessing technology to accelerate this process by, for example, automatically alerting a person’s friends when he or she signs up to become the fan of a particular brand or product on a site.

The big question is whether all this will translate into an advertising bonanza. “There is a pretty strong argument to be made that social networks are worth more than they are being given credit for,” says Andrew Lipsman, an analyst at comScore. But he cautions that the advertising industry may be slow to recognise the shift that is taking place. In a bid to speed things up, Facebook has struck an alliance with Nielsen to create a series of benchmarks for measuring the impact of social-network advertising on brands. Sheryl Sandberg, Facebook’s chief operating officer, says this will allow companies to get feedback on the effectiveness of their campaigns much faster than before.

Facebook has also been experimenting with new kinds of ads designed to draw people in, including some with embedded online polls or videos to which comments can be added. So far it has not come up with a killer format, but that does not seem to be holding it back. The company does not reveal numbers, but its revenues last year are thought to have been at least $500m and quite possibly more, which helped it to turn cash-flow positive in mid-2009. Against the backdrop of a world economy in recession and a dire advertising market, that is quite an achievement. It also suggests that Facebook can do well using a variety of different ad formats rather than a single, winning one. “There doesn’t have to be one enormous, oh my God hit,” says the IAB’s Mr Rothenberg.

Fun and gains

Nor does there have to be just one advertising-driven business model. In Asia several firms such as Japan’s GREE and China’s Tencent, which owns QQ, a service that includes a big online social network, are already making healthy profits from sales of games and virtual goods. In 2008 Tencent, which is listed on the Hong Kong Stock Exchange, reported revenues of just over $1 billion, with $720m coming from online gaming and sales of items such as digital swords and other virtual goods. Many Asian networks such as South Korea’s Cyworld and Japan’s Mixi also mint money by selling users custom backgrounds and other paraphernalia that allow them to personalise their network pages.

Inspired by this, firms elsewhere are embracing elements of the Asian model. Hi5, which is based in America and has 60m members around the world, has launched a number of games on its platform and created its own virtual currency, called Hi5 coins, for use in them. Alex St John, the firm’s chief technology officer, says that gaming and advertising can easily be combined by, for instance, persuading an advertiser to sponsor a currency used by players.

Ning is targeting gifts rather than games. In October it launched an initiative that allows people who have set up networks on its system to sell customised digital items to their members. These cost anything from 50 cents to $10, and over 400,000 of them are now being exchanged every month, with Ning splitting the profit equally with its customers. This will add to the revenues that it makes from ad sales and network-management fees. Even Facebook, with its focus on advertising, has a virtual warehouse of birthday cakes, champagne bottles and other goodies.

The beauty of this business for social networks is that the cost of producing and storing virtual inventory is minimal. Moreover, because these are closed markets, networks can fix prices at levels that generate fat margins. To some, the notion that big money can be made from selling make-believe items may seem bizarre. But the practice replicates the physical presents that people give to one another to cement relationships in the real world. Although Asia remains by far the biggest market for digital knick-knacks, Inside Network, a research firm, estimates that sales of virtual wares in America on many different kinds of websites have already exceeded $1 billion.

Plain or de luxe?

Another business model that has proved lucrative involves charging users for premium services. The networks that have been best at this have been the business-oriented kind. LinkedIn, for example, provides a free basic service, but asks users to pay a monthly subscription fee of up to $500 for extras, such as being able to send a larger number of introductory e-mails to other people on the site. The firm, which is said to have revenues of over $100m a year, also makes money by charging companies for online tools that help them track down talent. This “freemium” model plus a healthy dose of advertising from big brands aiming to reach its affluent audience has helped the network to turn a profit for several years running.

Social networks have also benefited from search engines’ desire to get their hands on more content. Twitter signed lucrative deals with Google and Microsoft’s Bing search service in October that allow both companies to include tweets from Twitter’s database in their search results. Thanks to these transactions the network is rumoured to have made a small profit last year, though it will not confirm this.

This year it plans to start making more money in two ways. The first involves charging firms for services such as tools for analysing discussions on Twitter and for authenticated accounts that let people know tweets they are receiving come from a genuine business. It is also hoping to profit from advertising by serving up targeted ads in the way Google does. Biz Stone, one of the firm’s co-founders, reckons that Twitter’s fans will be receptive to these because they already use the service to seek out information from others. They regularly share links to commercial sites and one survey last year found that as people twittered, they mentioned specific brands or products in 20% of their updates. That explains why Twitter and other social networks have caught the attention of millions of small businesses, as well as thousands of big ones.

From The Economist

4. Detroitosaurus wrecks

Task:

1. Read the article.

2. Make a prйcis and an annotation of the article.

The lessons for America and the car industry from the biggest industrial collapse ever

THE demise of GM had been expected for so long that when it finally died there was barely a whimper. Wall Street was unmoved. Congress did not draw breath. America shrugged. Yet the indifference with which the news was received should not obscure its importance. A company which once sold half the cars in America, employed in its various guises as many people as the combined populations of Nevada and Delaware and was regarded as a model for managers all over the world has just gone under; and its collapse holds important lessons about management, about government and about the future of the car industry.

Government and GM: a fatal mixture

GM’s architect, Alfred Sloan, never had Henry Ford’s entrepreneurial or technical genius, but he had organisation. He designed his company around the needs of his customers (“a car for every purse and purpose”). The divisional structure he created in the 1920s, with professional managers reporting to a head office through strict financial monitoring, was adopted by other titans of American business, such as GE, Dupont and IBM before the model spread across the rich world.

Although this model was brilliantly designed for domination, when the environment changed it proved disastrously inflexible. The problem in the 1970s was not really the arrival of better, smaller, lighter Japanese cars; it was GM’s failure to respond in kind. Rather than hitting back with superior products, the company hid behind politicians who appeared to help it in the short term. Rules on fuel economy distorted the market because they had a loophole for pickups and other light trucks—a sop to farmers and tool-toting artisans. The American carmakers exploited that by producing squadrons of SUVs, while the government restricted the import of small, efficient Japanese cars. If Detroit had spent less time lobbying for government protection and more on improving its products it might have fared better. Sensible fuel taxes would have hurt for a while, but unlike market-distorting fuel-efficiency rules, they would have forced GM to evolve.

As for the health and pension costs which have helped sink GM, the company and the government bear joint responsibility for those too. After the war GM rejected a mutual scheme that the unions wanted because it smacked of socialism; and around the same time, the company agreed to give retired workers full pensions and health care for life. But if successive administrations had dealt with America’s expensive and inadequate health care, the cost of those union demands would have been far lower. None of GM’s competitors has had to shoulder costs per worker anything like as heavy: until an agreement in 2007 with the union, each car in Detroit carried about $1,400 in extra pension and health-care costs compared with the foreign-owned competitors in America.

GM, Ford and Chrysler tried to improve: by 2006 they had almost caught up with Japanese standards of efficiency and even quality. But by then GM’s share of the American market had fallen to below a quarter. Rounds of closures and job cuts were difficult to negotiate with unions, and were always too little too late. Gradually the cars got better, but Americans had moved on. The younger generation of carbuyers stayed faithful to their Toyotas, Hondas or Mercedes assembled in the new cheaper car factories below the Mason-Dixon line. GM and the other American firms were left with the older buyers who were, literally, dying out.

GM’s demise should not be read as a harbinger of doom for the car industry. All around the world people want wheels: a car tends to be the first big purchase a family makes once its income rises much above $5,000 a year, in purchasing-power terms. At the same time as people in developing countries are getting richer, more efficient factories and better designs are making cars more affordable. That is why the IMF forecasts that the world will have nearly 3 billion cars in 2050, compared with around 700m cars today. In 40 years’ time the Chinese will have almost as many cars as exist in the whole of the world now. Indeed, GM’s own experience abroad shows the promise of emerging markets. Brazil has long been a source of profits, and GM has a leading position in China.

Yet although the long-term prospects for sales growth look excellent overall, the car industry has a problem: it needs to shrink dramatically. At present, there’s enough capacity globally to make 90m vehicles a year, but demand is little more than 60m in good economic times. Even as the big global manufacturers have been building new factories in emerging markets, governments in slow-growing rich-world markets have been bribing them to keep capacity open there.

Because the industry employs so many people and is a repository of high technology, governments are easily lured into the belief that car firms must be supported when times are tough. Hence Mr Obama’s $50 billion rescue of GM; and hence, too, the German government’s financial backing for the sale of Opel, GM’s European arm, to Magna, a Canadian parts-maker backed by a Russian state-owned bank. German politicians have made it clear that they plan to keep German factories open even if others elsewhere in Europe have to close. At least the American rescue recognises the need to remove capacity from the market—to cut the number of factories, workers and dealers.

It could still be a great business

For all its peculiarities, the car industry is no dinosaur—Toyota, for instance, is a byword for manufacturing excellence. But the unevolved GM deserved extinction. Detroit employed so many people and figured so large in American culture that governments felt they had to protect it; but in doing so, they made it vulnerable to less-coddled competitors from abroad. By trying to keep their car industry big, America’s leaders ended up preventing it from becoming good. There is a lesson in that which all governments would do well to learn.

From The Economist

Discussion point:

  •  Can any parallels be drawn between the problems faced by the automobile sectors in Russia and the US? What are the differences?

5. An offer you can't refuse*

Pre-reading question:

  •  What do you know about the United States' bankruptcy procedures and their Bankruptcy Code? What is the difference between Chapter 7, Chapter 9, Chapter 11, Chapter 12, Chapter 13, and Chapter 15?

Task:

1. Read the article and translate it into Russian.

2. Make an annotation of the article.

In its rush to save Detroit, the American government is trashing creditors’ rights

NO ONE who lent money to General Motors (GM) or Chrysler can have been unaware of their dire finances. Nor can workers have failed to notice their employers’ precarious futures. These were firms that barely stayed afloat in the boom and both creditors and employees were taking a punt on their promise to pay debts and generous health-care benefits.

The bet has failed. The recession has tipped both firms into the abyss—together they lost $48 billion in 2008. Chrysler has entered bankruptcy, from which it may emerge under Fiat’s control. GM could soon follow if efforts to hammer out a voluntary restructuring fail3. America’s government, keen to protect workers, is providing taxpayers’ cash to keep the lights on at both firms. But in its haste it has vilified creditors and ridden roughshod over their legitimate claims over the carmakers’ assets. At a time when many businesses must raise new borrowing to survive, that is a big mistake.

Bankruptcies involve dividing a shrunken pie. But not all claims are equal: some lenders provide cheaper funds to firms in return for a more secure claim over the assets should things go wrong. They rank above other stakeholders, including shareholders and employees. This principle is now being trashed. On April 30th, after the failure of negotiations, Chrysler entered Chapter 11. Under the proposed scheme, secured creditors owed some $7 billion will recover 28 cents per dollar. Yet an employee health-care trust, operated at arm’s length by the United Auto Workers union, which ranks lower down the capital structure, will receive 43 cents on its $11 billion-odd of claims, as well as a majority stake in the restructured firm.

The many creditors who have acquiesced include banks that themselves rely on the government’s purse. The objectors have been denounced as “speculators” by Barack Obama. The judge overseeing the case has consented to a quick, “prepackaged” bankruptcy, which seems to give little scope for creditors to argue their case or pursue the alternative of liquidating the company’s assets. In effect Chrysler and the government have overridden the legal pecking order to put workers’ health-care benefits above more senior creditors’ claims, and then successfully argued in court that the alternative would be so much worse for creditors that it cannot be seriously considered.

The Treasury has also put a gun to the heads of GM’s lenders. Unsecured creditors owed about $27 billion are being asked to accept a recovery rate of 5 cents, says Barclays Capital, whereas the health-care trust, which ranks equal to them, gets 50 cents as well as a big stake in the restructured firm. If creditors refuse to co-operate, the government will probably seek to squash them using the same fast-track legal process.

Chapter and verse

The collapse of Detroit’s giants is a tragedy, affecting tens of thousands of current and former workers. But the best way to offer them support is directly, not by gerrymandering the rules. The investors in these firms are easily portrayed as vultures, but many are entrusted with the savings of ordinary people, and in any case all have a legal claim that entitles them to due process. In a crisis it is easy to put politics first, but if lenders fear their rights will be abused, other firms will find it more expensive to borrow, especially if they have unionised workforces that are seen to be friendly with the government.

It may be too late for Chrysler’s secured creditors and if GM’s lenders cannot reach a voluntary agreement, they may face a similar fate. That would establish a terrible precedent. Bankruptcy exists to sort legal claims on assets. If it becomes a tool of social policy, who will then lend to struggling firms in which the government has a political interest?

From The Economist

6. Marriages made in hell

Task:

1. Read the article and translate it into Russian.

2. Make an annotation of the article.

The troubled history of carmakers' mergers

Mr Marchionne, the corporate troubleshooter, who, since 2004, has been responsible for a highly successful turnaround at Fiat, has reached the conclusion that volume carmakers will in future need to sell at least 5.5m vehicles a year to be viable. He reckons that only those firms, such as Volkswagen and Toyota, which can extract sales of around a million a year from each of a handful of expensively-developed platforms (these are a car’s architectural underpinnings, on which a variety of models can be based) can hope to be consistently profitable.

Adam Jonas of Morgan Stanley questions Mr Marchionne’s faith in scale, suggesting it is a function of success rather than prerequisite for it and gives warning that even successful mergers bring with them “many hidden cost burdens (financial and non-financial)” and that these can spiral if things do not go well.

Sceptics say cross-border mergers in the car industry have a poor record. Their doubts are rooted in experience. With the partial exception of the alliance formed between Renault and Nissan a decade ago, auto-industry mergers usually go wrong and destroy rather than create value. Two of the most notorious were the unhappy marriages between BMW and the ailing British car firm, Rover, and Chrysler’s own supposed “merger of equals” with Daimler-Benz. In both cases, the German premium-car maker believed that it needed increased scale and that taking over a volume maker would make this possible without a potentially risky brand extension.

In particular, BMW wanted a presence in the markets for small cars and for SUVs, while Daimler thought that Chrysler’s brands were below Mercedes’s, “but not too far below” and that it could learn from Chrysler’s skills as a low-cost producer—especially the way it handled supplier relationships and the speed with which it brought new products to market.

Not only was the premise behind both mergers mistaken—BMW and Mercedes have subsequently discovered that their brands can be safely extended much further than they had once believed—but the implementation was flawed from the outset for not dissimilar reasons. Although Chrysler had given every appearance of being in much better health than Rover (at the time of the merger with Daimler in 1998 it was one of the most profitable car companies in the world), both firms suffered from fundamental weaknesses that their German owners, partly out of mistaken tact and concern about provoking political hostility, acted only very belatedly to correct. Instead of doing the difficult things immediately, they let things drift.

In BMW’s case, it should have concentrated all its resources on reviving Land Rover and reinventing the Mini instead of lavishing resources on the dying Rover brand. BMW’s boss at the time, Bernd Pischetsrieder, believed that with BMW’s help Rovers could be exported as the “slightly premium” option in every segment, while BMWs would be the sportier, more expensive choice of keen drivers. It was a fantasy that masked the degree of Rover’s weakness and diverted BMW from doing more sensible things, such as consolidating purchasing and closing down the hopelessly outdated Longbridge factory in Birmingham.

A further problem was a growing rift within BMW as to whether the “English Patient” was worth the time and money it was absorbing. Far from ensuring BMW’s independence, Rover was imperilling it. In 2000 BMW finally extricated itself, paying some former Rover managers to take the thing away, selling Land Rover to Ford and keeping Mini. All told, the cost to BMW was about $7 billion and six years of heartache and distraction.

Something similar happened to the ill-fated DaimlerChrysler. Because it was meant to be “a merger of equals” and Chrysler was superficially in good shape when they bought it, the Germans waited far too long before dealing with some fairly obvious problems. Having allowed a leadership vacuum to develop at Auburn Hills (Chrysler’s HQ) as senior American managers who had been enriched by the deal drifted away, Daimler only acted to cut costs and capacity in late 2000 when the market had turned down and Chrysler was burning cash at a rate of $5 billion a year. But despite the best efforts of Dieter Zetsche, the Daimler manager sent out to get a grip on things, the cultural chasm between the two partners became wider.

In a bid to centralise purchasing, Daimler undermined one of the best things about Chrysler, its collaborative relationship with suppliers. Nor was there any synergy between the departments developing new models. Daimler's engineers thought Chrysler’s slapdash, while their American opposite numbers found them arrogant and ignorant about the needs of volume manufacture. The hope that platforms and powertrains would be shared was only implemented half-heartedly — the Germans in Stuttgart were reluctant to allow Chrysler technology they thought should be reserved for premium Mercedes cars.

Worse still, during the nine years of the marriage with Chrysler, Mercedes’s reputation for gold-standard quality took a battering. When in 2007 Daimler, now being run by the same Mr Zetsche who had tried to save Chrysler six years earlier, finally decided to bail out, its share price shot up. As a measure of the pitiful state in which the Germans had left Chrysler, its new model pipeline was almost empty and with only one or two exceptions the cars it was selling were old and uncompetitive.

The alliance between Renault and Nissan has, on the whole, been a much happier affair, although it is no longer regarded within the industry as quite such a shining exception as it was a few years ago when Carlos Ghosn, its architect, was the most feted car boss in the world. The secret, according to Mr Ghosn, has been in allowing the two companies to work as two distinct, but co-operating entities. He says: “You must be ambitious for the relationship, but not try to dominate or you will pay for it afterwards.” The alliance had taught Renault to become a global company and taught Nissan to be much bolder. Its guiding principle is that each can benefit from the other’s strengths.

For example, the alliance can boast class-leading powertrain technology thanks to Renault’s knowledge of diesel and Nissan’s highly-rated petrol engines and gearboxes. The key from the outset has been the cross-functional and cross-company teams, mainly of middle managers, set up by Mr Ghosn to engage in a permanent quest for new synergies. There must be, he says, complete transparency and a shared sense of purpose.

What Mr Ghosn could have added is that his own background (a Brazilian of Lebanese descent who was educated in France and speaks five languages) may have brought with it a cultural sensitivity that at times proved crucial. It is also almost certainly the case that both Renault and Nissan really could see strengths in each other they could learn from, whereas too many senior people at BMW and Daimler quickly grew contemptuous of the companies they had bought and were bad at hiding it.

From The Economist

7. The Walmart of the web

Task:

1. Read the article.

2. Make a prйcis and an annotation of the article.

Alternative task:

1. Read the articles and make a summary of it in class.

The internet giant’s new tablet computer fits its strategy of developing big businesses by charging small prices

A COUPLE of years after it launched its website in 1995, Amazon was the subject of an unflattering report entitled “Amazon.Toast”. The pundit who penned it predicted that the fledgling online bookseller would soon be crushed by Barnes & Noble (B&N), a book-retailing behemoth which had just launched its own site.

Far from being crushed, Amazon is doing the crushing. Borders, a once-mighty book chain, was flattened this year. B&N looks like a frightened capybara running from a fierce Brazilian she-warrior. Amazon is now one of the web’s most successful e-tailers. Even Apple is feeling the heat.

On September 28th Jeff Bezos, Amazon’s boss, unveiled a tablet computer called the Kindle Fire. It will compete with gadgets such as B&N’s Nook Color tablet and Apple’s iPad. The new Amazon tablet, which has a somewhat smaller screen than the iPad and only offers Wi-Fi connectivity, is likely to be just the first salvo in a titanic battle.

Like Apple, Amazon boasts a huge collection of online content, including e-books, films and music. And like Apple, it lets people store their content in a computing “cloud” and retrieve it from almost anywhere. But the two firms part company when it comes to pricing. The Kindle Fire, which will be available from mid-November in America, will cost only $199. That is far less than the cheapest iPad, a Wi-Fi-only device which costs $499. B&N responded to the Kindle Fire by cutting the price of its Nook Color to $224. This week Amazon also rolled out a new range of Kindle e-readers, the cheapest of which costs just $79. “We are building premium products and offering them at non-premium prices,” beamed Mr Bezos.

Amazon’s decision to undercut its rivals is partly a tactic designed to disrupt the tablet market, which is still dominated by the iPad. Gartner, a research firm, reckons that Apple’s device will account for almost three-quarters of the 64m tablets it thinks will be sold worldwide this year. Amazon’s pricing strategy also reflects one of the firm’s core beliefs, which is that cheap stuff makes customers cheerful. Call it the Walmart of the web.

Low prices are not the only thing underpinning Amazon’s success. The company is technologically adept, and it has a knack of delighting customers with innovations such as its $79-a-year “Amazon Prime” shopping service in America, which offers members free, two-day shipping and other benefits. Such goodies have been crucial to its growth. But its ability to drive down the prices of everything from cameras to cloud computing gives it a colossal competitive advantage.

A recent study by William Blair, an investment bank, underlines the price gap between Amazon and its rivals in the retailing world. The report compared the prices of 100 randomly selected goods at each of 24 American retailers with those items that were also available on Amazon.com. It found that almost half of the goods were listed on the online retailer’s site too, and that Amazon’s prices for individual products were on average 11% below those of the stores. The study also noted that Amazon’s discounts were in many cases deeper than those offered by the retailers’ own websites.

Admittedly, as an online outfit Amazon does not pay sales tax in American states where it has no physical presence. Many cash-strapped states are now keen to pass laws that would change this—a move Amazon is loudly and unsurprisingly opposing. But the William Blair study concludes that even if it has to cough up more tax, Amazon will still be able to offer prices that are lower than many rivals’. The firm’s huge scale and its massively popular website, which it will use to promote the Kindle Fire, give it an edge. And it enjoys another advantage too. “Amazon does not have to worry about the impact of its pricing on a legacy store system,” explains Kirthi Kalyanam, a professor at Santa Clara University’s Retail Management Institute.

Amazon Web Services (AWS), which rents computing capacity in its giant data centres to customers, has also won a reputation for being cheap. Comparing cloud-computing prices is tricky, but observers of the market report that AWS is typically one of the lowest-cost providers. “Amazon operates with economies of scale that are practically impossible to match,” says Reuven Cohen of Enomaly, which runs SpotCloud, an online marketplace where firms sell excess cloud-computing capacity.

The cloud is crucial to the success of Amazon’s gadget strategy. Most analysts think that the firm loses money on the hardware that it sells. But it hopes that its cheap tablet will be wildly popular and therefore boost sales of Amazon’s cloud-based content, just as the Kindle e-reader boosted sales of e-books. It’s like free parking outside Walmart—you want potential customers to see what’s in the window.

The good news for Amazon is that tablet users seem more inclined to splash out on stuff than web shoppers who use PCs, according to Forrester, another research firm. One possible explanation for this is that tablet buyers tend to be richer; another is that the immersive experience tablets create encourages more impulse buying.

Whatever the reason, Amazon will have to hope that its gambit works, because its business model has at least one worrying downside. Its profit margin is a page-thin 3-4%, partly because it has invested so heavily in the cloud. Now it is going head-to-head with Apple, which made a juicy $7.3 billion net profit on revenues of $28.6 billion in the latest quarter. Apple may not want to provoke a price war in the tablet market, where it sees plenty of growth to come. But if it does return fire, Amazon could get its fingers toasted.

From The Economist

8. Big and clever

Task:

1. Read the article.

2. Make a prйcis and an annotation of the article.

Why large firms are often more inventive than small ones

SOME people say it is neither big nor clever to drink. Viz, a British comic, settled that debate with a letter from a reader who said: “I drink 15 pints a day, I’m 6 foot 3 inches tall and a professor of theoretical physics.” However, another question about size and cleverness has yet to be resolved. Are big companies the best catalysts of innovation, or are small ones better?

Joseph Schumpeter argued both sides of the case. In 1909 he said that small companies were more inventive. In 1942 he reversed himself. Big firms have more incentive to invest in new products, he decided, because they can sell them to more people and reap greater rewards more quickly. In a competitive market, inventions are quickly imitated, so a small inventor’s investment often fails to pay off.

These days the second Schumpeter is out of fashion: people assume that little start-ups are creative and big firms are slow and bureaucratic. But that is a gross oversimplification, says Michael Mandel of the Progressive Policy Institute, a think-tank. In a new report on “scale and innovation”, he concludes that today’s economy favours big companies over small ones. Big is back, as this newspaper has argued. And big is clever, for three reasons.

First, says Mr Mandel, economic growth is increasingly driven by big ecosystems such as the ones that cluster around Apple’s iPhone or Google’s Android operating system. These ecosystems need to be managed by a core company that has the scale and skills to provide technological leadership.

Second, globalisation puts more of a premium on size than ever before. To capture the fruits of innovation it is no longer enough to be a big company by American standards. You need to be able to stand up to emerging-world giants, many of which are backed by something even bigger: the state.

Third, many of the most important challenges for innovators involve vast systems, such as education and health care, or giant problems, such as global warming. To make a serious change to a complex system, you usually have to be big.

If true, this argument has profound implications for policymakers (though Mr Mandel does not spell them out). Western governments are obsessed with promoting small businesses and fostering creative ecosystems. But if large companies are the key to innovation, why not concentrate instead on creating national champions? Anti-trust regulators have strained every muscle to thwart the creation of monopolies (for example, by preventing AT&T, a telecoms firm, from taking over the American arm of T-Mobile). But if one behemoth is likely to be more innovative than two smaller companies, why not allow the merger to take place?

What should we make of Mr Mandel’s argument? He is right that the old “small is innovative” argument is looking dated. Several of the champions of the new economy are firms that were once hailed as plucky little start-ups but have long since grown huge, such as Apple, Google and Facebook. (In August Apple was the world’s largest listed company by market capitalisation.) American firms with 5,000 or more people spend more than twice as much per worker on research and development as those with 100-500. The likes of Google and Facebook reap colossal rewards from being market-makers rather than market-takers.

Big companies have a big advantage in recruiting today’s most valuable resource: talent. (Graduates have debts, and many prefer the certainty of a salary to the lottery of stock in a start-up.) Large firms are getting better at avoiding bureaucratic stagnation: they are flattening their hierarchies and opening themselves up to ideas from elsewhere. Procter & Gamble, a consumer-goods giant, gets most of its ideas from outside its walls. Sir George Buckley, the boss of 3M, a big firm with a 109-year history of innovation, argues that companies like his can combine the virtues of creativity and scale. 3M likes to conduct lots of small experiments, just like a start-up. But it can also mix technologies from a wide range of areas and, if an idea catches fire, summon up vast resources to feed the flames.

However, there are two objections to Mr Mandel’s argument. The first is that, although big companies often excel at incremental innovation (ie, adding more bells and whistles to existing products), they are less comfortable with disruptive innovation—the kind that changes the rules of the game. The big companies that the original Schumpeter celebrated often buried new ideas that threatened established business lines, as AT&T did with automatic dialling. Mr Mandel says it will take big companies to solve America’s most pressing problems in health care and education. But sometimes the best ideas start small, spread widely and then transform entire systems. Facebook began as a way for students at a single university to keep in touch. Now it has 800m users.

The second is that what matters is not so much whether companies are big or small, but whether they grow. Progress tends to come from high-growth companies. The best ones can take a good idea and use it to transform themselves from embryos into giants in a few years, as Amazon and Google have. Such high-growth firms create a lot of jobs: in America just 1% of companies generate roughly 40% of new jobs.

Let small firms grow big

Politicians should certainly stop demonising big firms and sentimentalising small ones: an economy needs both. But they should not allow their new-found appreciation of big companies to degenerate into a taste for picking national champions. Such firms typically gobble subsidies and crowd out smaller, more creative firms. Nor should they start tolerating monopolies. The key to promoting innovation (and productivity in general) lies in allowing vigorous new companies to grow big, and inefficient old ones to die. On that, Schumpeter never changed his mind.

From The Economist

Presentation point:

  •  Make a report about an innovative company. Outline the main factors which have contributed to its success, don't forget to mention the product the company is famous for and its distinguishing features. A presentation with Power Point support is welcome!

9. Asia’s new model company

Task:

1. Read the article.

2. Make a prйcis and an annotation of the article.

Alternative task:

1. Read the articles and make a summary of it in class.

Samsung’s recent success has been extraordinary. But its strategy will be hard to copy

THE founders of South Korea’s chaebol (conglomerates) were an ambitious bunch. Look at the names they picked for their enterprises: Daewoo (“Great Universe”), Hyundai (“The Modern Era”) and Samsung (“Three Stars”, implying a business that would be huge and eternal). Samsung began as a small noodle business in 1938. Since then it has swelled into a network of 83 companies that account for a staggering 13% of South Korea’s exports. The hottest chilli in the Samsung kimchi bowl is Samsung Electronics, which started out making clunky transistor radios but is now the world’s biggest technology firm, measured by sales. It makes more televisions than any other company, and may soon displace Nokia as the biggest maker of mobile-telephone handsets.

Small wonder others are keen to know the secret of Samsung’s success. China sends emissaries to study what makes the firm tick in the same way that it sends its bureaucrats to learn efficient government from Singapore. To some, Samsung is the harbinger of a new Asian model of capitalism. It ignores the Western conventional wisdom. It sprawls into dozens of unrelated industries, from microchips to insurance. It is family-controlled and hierarchical, prizes market share over profits and has an opaque and confusing ownership structure. Yet it is still prodigiously creative, at least in terms of making incremental improvements to other people’s ideas: only IBM earns more patents in America. Having outstripped the Japanese firms it once mimicked, such as Sony, it is rapidly becoming emerging Asia’s version of General Electric, the American conglomerate so beloved of management gurus.

Tomorrow’s GE or tomorrow’s Daewoo?

There is much to admire about Samsung. It is patient: its managers care more about long-term growth than short-term profits. It is good at motivating its employees. The group thinks strategically: it spots markets that are about to take off and places huge bets on them.

The bets that Samsung Electronics placed on DRAM chips, liquid-crystal display screens and mobile telephones paid off handsomely. In the next decade the group plans to gamble again, investing a whopping $20 billion in five fields in which it is a relative newcomer: solar panels, energy-saving LED lighting, medical devices, biotech drugs and batteries for electric cars. Although these industries seem quite different from each other, Samsung is betting that they have two crucial things in common. They are about to grow rapidly, thanks to new environmental rules (solar power, LED lights and electric cars) or exploding demand in emerging markets (medical devices and drugs). And they would benefit from a splurge of capital that would allow large-scale manufacturing and thus lower costs. By 2020 the Samsung group boldly predicts that it will have sales of $50 billion in these hot new areas, and that Samsung Electronics will have total global sales of $400 billion.

It is easy to see why China might like the chaebol model. South Korea’s industrial titans first prospered in part thanks to their close ties with an authoritarian government (though Samsung was not loved by all the generals). Banks were pressured to pump cheap credit into the chaebol, which were encouraged to enter dozens of new businesses—typically macho ones such as shipbuilding and heavy industry. Ordinary Koreans were chivvied to save, not consume. South Korea grew into an exporting powerhouse. Does this sound familiar?

In China, too, the state draws up long-term plans, funnels cash to industries it deems strategic and works hand-in-glove with national champions, like Huawei and Haier. Some of Beijing’s planners would love to think that state intervention is the route to world-beating innovation. No doubt inadvertently, Samsung feeds this delusion.

Of hindsight and survivor bias

For delusion it is, on three levels. Most broadly, South Korea’s prosperity owes less to dirigisme than China’s dirigistes believe, and nothing to dictatorship—South Korea is now a democracy, and much happier for it. Second, the chaebol system has been less beneficial for South Korea than Samsung’s success might imply. Some of the state-directed cheap credit that powered the chaebol produced superb companies, such as Samsung Electronics and Hyundai Motors. But it yielded some costly failures, too. During the Asian financial crisis of 1997-98, half of the top 30 chaebol went bust because they had expanded recklessly. Daewoo, the Great Universe, is no more.

Defenders of the chaebol say that the crisis spurred reforms, curbing the tendency of the chaebol to overborrow and overexpand. They don’t hog credit as much as before—Samsung Electronics now generates oceans of cash to finance its expansion plans. But in general the giants still crowd out small entrepreneurial firms: a former boss of Samsung Electronics has warned that South Korea has too many eggs in too few baskets. And despite a decade of political reform, the ties between the chaebol and the state are still too cosy. President Lee Myung-bak (the ex-boss of a Hyundai firm) has pardoned dozens of chaebol bosses convicted of corporate crimes.

As for Samsung, it is an admirable company, packed full of individual successes that managers (and not just ones in Asia) should study. But inevitably it has not always got everything right—who now drives a Samsung car? And its overall success is not easily replicable. Samsung is patient and bold because the family of its late founder, Lee Byung-chull, wants it to be. Family control is guaranteed by a complex web of cross-shareholdings. This is fine so long as the boss is as brilliant as the late Lee or his son, Lee Kun-hee, the current chairman. But if the founder’s grandson, who is being groomed for the top job, fails to measure up, he will be harder for the company’s shareholders to oust than his peers at GE, Sony and Nokia.

To that extent, for all its modern technology, Samsung’s story is an old one writ new—the well-run family firm, with a strong culture and a focus on the long term, which has made good use of an indulgent state. Celebrate it on those grounds and Asia’s new model has something going for it. Just don’t expect it to keep going at its current rate for ever.

From The Economist

10. The rise of state capitalism

Task:

1. Read the article.

2. Make a prйcis and an annotation of the article.

The spread of a new sort of business in the emerging world will cause increasing problems

OVER the past 15 years striking corporate headquarters have transformed the great cities of the emerging world. China Central Television’s building resembles a giant alien marching across Beijing’s skyline; the 88-storey Petronas Towers, home to Malaysia’s oil company, soar above Kuala Lumpur; the gleaming office of VTB, a banking powerhouse, sits at the heart of Moscow’s new financial district. These are all monuments to the rise of a new kind of hybrid corporation, backed by the state but behaving like a private-sector multinational.

State-directed capitalism is not a new idea: witness the East India Company. But it has undergone a dramatic revival. In the 1990s most state-owned companies were little more than government departments in emerging markets; the assumption was that, as the economy matured, the government would close or privatise them. Yet they show no signs of relinquishing the commanding heights, whether in major industries (the world’s ten biggest oil-and-gas firms, measured by reserves, are all state-owned) or major markets (state-backed companies account for 80% of the value of China’s stockmarket and 62% of Russia’s). And they are on the offensive. Look at almost any new industry and a giant is emerging: China Mobile, for example, has 600m customers. State-backed firms accounted for a third of the emerging world’s foreign direct investment in 2003-10.

With the West in a funk and emerging markets flourishing, the Chinese no longer see state-directed firms as a way-station on the road to liberal capitalism; rather, they see it as a sustainable model. They think they have redesigned capitalism to make it work better, and a growing number of emerging-world leaders agree with them. The Brazilian government, which embraced privatisation in the 1990s, is now interfering with the likes of Vale and Petrobras, and compelling smaller companies to merge to form national champions. South Africa is also flirting with the model.

This development raises two questions. How successful is the model? And what are its consequences—both in, and beyond, emerging markets?

The law of diminishing returns

State capitalism’s supporters argue that it can provide stability as well as growth. Russia’s wild privatisation under Boris Yeltsin in the 1990s alarmed many emerging countries and encouraged the view that governments can mitigate the strains that capitalism and globalisation cause by providing not just the hard infrastructure of roads and bridges but also the soft infrastructure of flagship corporations.

So Lee Kuan Yew’s government in Singapore, an early exponent of this idea, let in foreign firms and embraced Western management ideas, but also owned chunks of companies. The leading practitioner is now China where there is a tight connection between its government and business and both sides tend to have the same point of view.

The new model bears little resemblance to the disastrous spate of nationalisations in Britain and elsewhere half a century ago. China’s infrastructure companies win contracts the world over. The best national champions are outward-looking, acquiring skills by listing on foreign exchanges and taking over foreign companies. And governments are selective in their corporate holdings. Overall, the Chinese state has loosened its grip on the economy: its bureaucrats concentrate on industries where they can make a difference.

Let a thousand mobiles bloom

Yet a close look at the model shows its weaknesses. When the government favours one lot of companies, the others suffer. In 2009 China Mobile and another state giant, China National Petroleum Corporation, made profits of $33 billion—more than China’s 500 most profitable private companies combined. State giants soak up capital and talent that might have been used better by private companies. Studies show that state companies use capital less efficiently than private ones, and grow more slowly. In many countries the coddled state giants are pouring money into fancy towers at a time when entrepreneurs are struggling to raise capital.

Those costs are likely to rise. State companies are good at copying others, partly because they can use the government’s clout to get hold of their technology; but as they have to produce ideas of their own they will become less competitive. State-owned companies make a few big bets rather than lots of small ones; the world’s great centres of innovation are usually networks of small start-ups.

Nor does the model guarantee stability. State capitalism works well only when directed by a competent state. Many Asian countries have a strong mandarin culture; South Africa and Brazil do not. Coal India is hardly an advertisement for efficiency. And everywhere state capitalism favours well-connected insiders over innovative outsiders. In China highly educated princelings have taken the spoils. In Russia a clique of “bureaugarchs”, often former KGB officials, dominate both the Kremlin and business. Thus the model produces cronyism, inequality and eventually discontent—as the Mubaraks’ brand of state capitalism did in Egypt.

Rising powers have always used the state to kick-start growth: think of Japan and South Korea in the 1950s or Germany in the 1870s or even the United States after the war of independence. But these countries have, over time, invariably found that the system has limits. The Chinese of all people should understand that the best way to learn from history is to look at its long sweep.

But it may take many years for the model’s weaknesses to become obvious; and, in the meantime, it is likely to cause all sorts of problems. Investors in emerging markets, for instance, need to watch out. Some may be taking a punt on governments as much as companies. State-capitalist governments can be capricious, with scant regard for minority shareholders. Others may find their subsidiaries or joint ventures in emerging markets pitted against state-backed favourites.

Another concern is the impact of the model on the global trading system—which, at a time when the likely Republican nominee for president wants to declare China a currency manipulator on his first day of office, is already at risk. Ensuring that trade is fair is harder when some companies enjoy the support, overt or covert, of a national government. Western politicians are beginning to lose patience with state-capitalist powers that rig the system in favour of their own companies.

For emerging countries wanting to make their mark on the world, state capitalism has an obvious appeal. It gives them the clout that private-sector companies would take years to build. But its dangers outweigh its advantages. Both for their own sake, and in the interests of world trade, the practitioners of state capitalism need to start unwinding their huge holdings in favoured companies and handing them over to private investors. If these companies are as good as they boast they are, then they no longer need the crutch of state support.

From The Economist

Discussion point:

  •  Do you share the author's point of view on the problems that the rise of the so-called "state capitalism" may entail?

* Articles marked with an asterisk (*) are intended for offhand translation.

2 “E-commerce and the Market Structure of Retail Industries”, by Maris Goldmanis, Ali Hortaçsu, Chad Syverson and Önsel Emre. Economic Journal, June 2010

3 Chrysler eventually emerged from Chapter 11 bankruptcy on June 10th, 2009 and is now controlled by Fiat. GM filed for a Chapter 11 bankruptcy just a couple of days before, on June 8th, and emerged from it on July 10th, 2009.

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