State capitalism is an economic system in which governments manipulate market outcomes for political purposes. Governments embrace state capitalism because it serves political as well as economic purposes--not because it's the most efficient means of generating prosperity. It puts vast financial resources within the control of state officials, allowing them access to cash that helps safeguard their domestic political capital and, in many cases, increases their leverage on the international stage. But state capitalism also stems the rise of globalization, because to varying degrees it hampers the flow of ideas, information, people, money, goods, and services within countries and across international borders.

As the Cold War stumbled to a close, the belief that governments could micromanage national economies and generate prosperity seemed dead. The dynamism and market power of Japan, the United States, and Western Europe--fueled by private wealth, private investment, and private enterprise--appeared to have fully and finally established the dominance of the liberal economic model. As these countries' governments privatized businesses and pensions, companies such as Exxon Mobil, Microsoft, Toyota Motor, and Wal-Mart Stores feverishly sketched out global expansion plans. Globalization became a household word.

Yet, despite the massive state interventions in economies across both the developed and developing worlds, many corporate leaders and investors act as though globalization remains the dominant paradigm. That is a mistake. In fact, the new importance of the state had become obvious well before the onset of the current crisis. Energy markets provide a good example.

The story extends well beyond energy. Across a broad range of economic sectors, China and Russia are leading the way in the strategic deployment of state-owned enterprises, and other governments have begun to follow their lead. In defense, a growing number of emerging-market governments--power generation, telecom, metals, minerals, and aviation--not content with simply regulating markets, are moving to dominate them.

Such state-corporate activity is fueled in part by the emergence of a new class of sovereign wealth funds. States with large holdings in the currencies of other countries are establishing ever larger risk-taking funds meant to maximize their return on investment--and their political influence. With the global credit squeeze making funds harder to come by, sovereign wealth funds have become even more important for the financing of state capitalism.

The global recession has accelerated the trend of state involvement in markets as governments around the world spend billions to stimulate growth and bail out vulnerable domestic industries and companies.

Winners and losers As the landscape shifts around them, international companies and investors will discover that the large-scale injection of politics into market processes will produce its own set of winners and losers. Because political factors unique to each state will determine the response to each domestic economic slowdown, countries with relatively strong political fundamentals will have a better shot at a quick recovery.

Given the vast sums its government can spend on fiscal stimulus, China will likely emerge from the global recession before most of the developed world.

In Brazil, President Luiz Inácio Lula da Silva has over the past several years forged a durable consensus in favor of disciplined macroeconomic policy.

Second-order effects

There are other implications of these trends worth considering.

We're likely to see new restrictions on the access to certain foreign markets for some companies.

• Tit-for-tat protectionism will remain a serious threat until the global recession comes to an end.
• Social upheaval will pressure politicians to turn increasingly toward a familiar and reliable tool: subsidies.
  
• Some of the regulatory changes will favor domestic firms... and SOME domestic firms.

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