It looks, at first, like just another bubble in emerging equities. Following the acquisition of IBM’s PC business by China’s Lenovo, Chinese businesses are in the headlines. The usual suspects are up – Brazil, Russia, Turkey. Americans who once feared a rising Japan now talk of a rising India. All of which usually means, sooner or later, another emerging market meltdown. But there is an important difference.

That difference is Nigeria. Or, more specifically, the fact that Nigeria became, in 2004, the third largest global market for Guinness breweries – trailing only Ireland and Britain in Guinness’s global sales and edging out the United States. So odd a fact cannot be dismissed as a fluke. There are no speculative bubbles in beer consumption.

Nigeria’s unlikely rise is, in fact, the harbinger of a trend that is changing the global business landscape. That trend is not a simple expansion of wealth. Since the early 1990s emerging markets enthusiasts have made much of the fact that the combined output of the developing economies is, by some measures, roughly on par with that of the rich world. But this sizeable economic output does not make the emerging markets relevant to global business – any more than the Warsaw Pact economies were relevant to global business during the days of the USSR.

To be relevant, economies must be integrated. Until recently the emerging markets were cordoned off by barriers of politics, policy, culture, and sheer economic difference. These barriers were as real as any iron curtain. Trade flows between countries with different languages, political systems, and average incomes have long been dramatically lower than standard economic models would predict.

A famous illustration of this is the case of Whirlpool India. In the late 1980’s, Whirlpool invested heavily in India, lured by talk of a middle class some 200-million strong. But impenetrable differences of culture and consumer income separated Whirlpool from its intended market. Labor-saving devices made little sense in a country with a labor surplus. Electronic appliances caused more problems than they solved for customers who suffered frequent power cuts. By the mid-1990’s, Whirlpool India was losing over $10 million a year. Such all-too-common stories led many Western executives to conclude that emerging market consumers were little more than a mirage.

But this is changing. When Guinness went to Nigeria, no doubt with low expectations, it stumbled into the ideal market for its product. Guinness, originally brewed to withstand long sea voyages, was well-matched to the refrigeration breakdowns and road delays that plague Nigeria’s distribution system. This was coupled with good strategy. During Nigeria’s frequent economic crises, Guinness counterintuitively but cleverly increased its investment in the country, acquiring assets and taking market share from floundering competitors on the cheap. To this add low-cost local production and a well-honed marketing campaign, and you have a formula for outsize success.

Thus Guinness tapped into a market that, prior to its efforts, was so far from the mind of global businesspeople that it might as well have been on Mars. There are 130 million Nigerians, and though they remain poor, their combined spending power exceeds that of all of Ireland. In the struggle between brewers like Diageo, which owns Guinness, and Anheuser-Busch, Heineken and others, the Nigerian market suddenly matters.

Countries that once served only as the setting for resource extraction ventures are now integrating via offshoring, outsourcing, and as consumer markets. Thailand is now the world’s second-largest producer of pickup trucks; Indonesia the fifth-largest market for cigarettes; and US insurer AIG derives about half of its operating profits in its core life insurance business from Asia.

This means a fundamental shift in the competitive landscape for global business. One telling indicator of this is the degree to which emerging market firms are no longer just acquisition targets, but are strong competitors in their own right. India’s Tata Group bought the telecoms arm of US-based Tyco, Mexican cement giant Cemex acquired Britain’s RMC, and Chinese firms have been eyeing targets worldwide. Home-grown emerging market firms have exploited their countries’ hidden wealth to attain global scale.

To be sure, emerging market equities may fall just as quickly as they have risen. Bubbles and busts are not things of the past. But the trends of economic integration are deep and not easily reversed. China has been the world’s most favored destination for foreign direct investment for three years running, in A.T. Kearney’s rankings. India, riding its outsourcing boom, has now moved up to second place, displacing the United States. And then there is the rise of Nigeria in the ranks of beer consuming nations. Though unheralded, this is no less a signal to the globe’s captains of industry – at long last, the emerging markets have emerged.

Microsoft's success in the U.S. market is uncanny and ongoing. But in countries on opposite sides of the world, things sometimes go wrong for the wizards of Redmond. Brazilian authorities have announced plans to convert five federal government ministries from Windows to mandatory use of open-source software. In Beijing, representatives of the Chinese, Japanese and Korean governments have been meeting to hash out a joint plan to promote the usage of Linux. And in Europe, the competition authorities handed down a monopoly ruling and fine that cut deeply into Microsoft's global earnings.

This may seem out of character for Microsoft, a company known for its unerring command of strategy. Or perhaps coincidental.

But far from it. Consider the telling blunder Microsoft made in the Korean software market in the summer of 1998.

That summer, in the face of determined local competition, Microsoft was struggling with a minority market share. Then the company's strategists hit on a bold plan. The Korean software firm that dominated the local word processing market was bleeding cash.
Because of rampant software piracy, many Koreans were using the company's software, but few were paying for it. Cash-rich Microsoft negotiated a deal in which the Korean company would discontinue producing its software in return for a bailout from Microsoft -- leaving the word-processing market open for domination by Microsoft Word.

An aggressive strategy. But what Microsoft failed to understand is that there is something unique about the Korean written language. Most alphabets have evolved organically over the centuries and aren't related to national boundaries. (The letters A through Z are used, with some modification, to inscribe everything from Finnish to Turkish.) Korea's alphabet, called Hangul, was, by contrast, decreed into being in the 1400s by a Korean king who declared, "Koreans are in great need of their own letters."

When Japan forcibly colonized Korea in the early 1900s, it outlawed use of Hangul and forced Koreans to take Japanese names. Hence when Korea was liberated at the end of the Second World War, writing in Korea's unique national alphabet became a potent -- indeed spectacularly potent -- symbol of independence, resistance to foreign domination, and patriotism. So much so, that the government established "Hangul Day,"
Oct. 9, as a national holiday. (It's probably the world's only holiday in honor of an alphabet.)

Lee Chan-jin, the man who produced the first Korean-language word-processing program -- that is, the first program to make composition in Hangul on the computer possible -- became something of a national hero. Indeed, in a late-1990s poll of Korean college students asking about their role models, Lee took second place, only running behind the chairman of Hyundai.

When Microsoft's plans for the forcible retirement of Lee Chan-jin's software were made public, the backlash was spectacular. Korean editorialists penned personal attacks on Bill Gates. Outraged Koreans actually donated money to venture capitalists making a local counter-offer. A grass-roots campaign against Microsoft sprang up. Microsoft was soon forced to abandon its strategy and concede defeat. In the aftermath, patriotic Korean software users, incensed by Microsoft's actions, for the first time began to pay for their software, and that sent Microsoft's local competition on a brief but meteoric upward rise at the end of the 1990s.

To be sure, these extraordinary events had little impact on Microsoft's global performance in 1998. But they revealed a critical flaw that is now returning to haunt the company: When devising international strategy, Microsoft ignores the kimchi.

Kimchi is a Korean staple dish of cabbage fermented in garlic, chilies and vinegar until it is spicy, blood-red in color, and gives off a pungent aroma.
Unlike the Big Mac and Coke, the official food and drink combo of globalization, kimchi is still a quintessentially local dish, associated with a particular country and people. While researching a recent book on global business strategy, my co-authors and I came to see kimchi as the symbol for the idiosyncrasies of local politics, economics and culture. To get Korea right, you have to know about the kimchi.

In a strategic context, understanding the kimchi means more than retouching a U.S. product or marketing campaign with a little local flavor. (In Seoul, for instance, McDonald's will sell you a kimchi burger.) Nor is it enough to wine and dine the local leadership. Microsoft, especially in China, has spent ample time and treasure on this.

Rather, it means adjusting business strategies to suit foreign peculiarities. When strategies from a home market are transported abroad without modification, they may underperform or even backfire spectacularly, as happened to Microsoft in Korea. There are national differences in politics, wealth, commercial environment, infrastructure, history, language, and so on.

The result is a stark and persistent pattern in international trade and investment flows: Despite the ongoing decline in transport and communication costs, the volume of business transacted between distant countries remains stubbornly low. It is no longer hard to get products to distant overseas markets. But it is still hard to do well in those markets.

When Microsoft and many other companies craft international strategies, too often they ignore such concerns. The kimchi is not a factor they recognize.
Instead they attempt to replicate highly successful U.S. strategies overseas. Microsoft exploits software's economics to attain market dominance in one category, and then spreads to neighboring product categories by bundling them with the first successful product.

But this approach, as the events in Korea hinted, and this year's setbacks in Latin America, Asia and Europe are now proving, does not always work. Microsoft's U.S. strategy already pushes the boundaries of political and judicial acceptability. In foreign markets, this strategy almost inevitably involves crushing national champions and fuels the perception
-- however unjustified -- that "monopoly profits" are being stripped from local hands and shipped back to Redmond.

Microsoft declined to comment for this article. In the company's defense, however, it is important to note that in Southeast Asia, Microsoft has just launched an initiative offering stripped-down local-language versions of Windows at sharply reduced prices. That is a step in exactly the right direction, a strategy in tune with local markets. This praise is not yet fully deserved, though: Microsoft only started the program after the Thai government began distributing a low-cost computer pre-loaded with Linux to its citizens.

Could Microsoft get more in tune with the kimchi? It certainly could, but that would involve some strategic innovation. Partnering with national champions, instead of crushing them, for example. That may contradict the company's stunningly successful modus operandi in America. But a strategy that ignores the kimchi, at best, dramatically increases Microsoft's global risks. At worst, it may undermine Microsoft's international expansion.

[This article originally appeared in Barron's on September 20, 2004 - Ed.]

An earthquake of devastating magnitude struck, in 1976, not far from Beijing. As the survivors’ stories trickled out, the world rushed to China’s assistance. But the Chinese government refused all outside aid and claimed the situation was well in hand. Partly as a result, the casualty figures were, in the end, astronomical. At least 242,000 died – the official figure, released years later – and some reputable sources claim that over 700,000 perished.

The problem was the timing. It has been a basic tenet of Chinese political philosophy for more than two millennia that governments rule with the “mandate of heaven,” and that natural disasters – including floods, droughts and earthquakes – are a heaven-sent signal that this mandate has been revoked and the leadership had failed. In 1976, Mao was on his deathbed, and the unsteady Chinese government feared the political consequences of the quake. Lest anyone conclude their mandate was up, the government tried to cover up the earthquake’s magnitude, at the expense of Chinese lives.

But then, Confucian teachings aside, there is ample precedent that natural disasters beget instability. Simon Winchester popularized the argument that the volcanic explosion which destroyed the Indonesian island of Krakatoa in 1884 lead to a bloody peasant’s revolt against Dutch colonial rule, and fostered the growth of militant Islam in that country.

In 1954, following a devastating hurricane, the Haitian government’s outright theft of international relief aid was so blatant that the president was eventually driven from office. In 1970, following a devastating typhoon that killed perhaps 400,000 people, the Pakistani government’s perceived failure to respond helped fuel a civil war between eastern and western Pakistan. (The typhoon hit the east; the unresponsive government was based in the west.) This led to the secession of Bangladesh.

Just as famously, a 1972 earthquake fueled the growth of an opposition movement that eventually overthrew the government of Nicaragua. The bungled response of the US-backed government of Iran to a 1978 quake allowed the country’s Islamic revolutionaries to rally support. And “twin” earthquakes in Mexico City in 1985 assisted the rise of the leftist PRD, which gained power in local government and very nearly the presidency.

After the Asian tsunami, Indonesia is an obvious candidate for instability. The last major catastrophe to strike Indonesia was not natural, it was man-made – an economic collapse following the Asian financial crisis. This led to an orgy of political violence by Indonesian Muslims against the country’s ethnic Chinese that left over 1,000 dead.

Catastrophes, whatever their form, tend to leave people disoriented and in search of an explanation for their suffering – an explanation which will tell them how they can lessen their pain. Indonesian rabble-rousers blamed the country’s economic collapse, erroneously, on Indonesians of Chinese descent, and Indonesia’s ethnic Malays rose up to kill their Chinese countrymen.

The risk, of course, is that the trauma of the tsunami will give separatist rebels in Indonesia’s hard-hid Aceh province new political life. The rebels can blame the people’s suffering on the government’s failure to provide for them. And yet, given the events of the past year, this risk is limited. Under cover of the global war on terror, the Indonesian government has conducted a bloody, heavy-handed crackdown in Aceh that has weakened the rebels. This continues even now – the Indonesian government announced that all foreign aid workers in Aceh would be accompanied by the Indonesian army, for instance. In the near term at least, the greater danger is of an uncontrolled crackdown than an uncontrolled rebellion.

In Sri Lanka, the tsunami may well have a more profound impact. The Tamil Tiger rebels in northern Sri Lanka have waged a decades-long civil war against the Sri Lankan government that has killed over 64,000 people. The secret to the Tiger’s longevity has been tremendous external funding.

In past decades, over a hundred thousand ethnic Tamils have fled Sri Lanka, chiefly as a result of anti-Tamil violence by the country’s majority Sinhalese. These Tamils – now residents of the US, UK, Canada, and other rich countries – have sent tremendous sums of money to the Tamil rebels fighting at home. (At one time, Canada’s ethnic Tamils alone sent their countrymen over $20 million per year.) These funds have allowed the Tamil Tigers to buy the arms and supplies necessary to run a bloody guerilla war.

All this stopped after September 11th. Governments worldwide cracked down on terrorist funding, and ethnic Tamils overseas were no longer comfortable funding violence, even for a cause they believed in. (One of the Tigers’ main tactics is suicide bombing.) With their funds drying up, the Tigers laid down their arms and entered peace talks with the Sri Lankan government in 2002.

The danger is that the tsunami could overturn this arrangement, first because the quake’s trauma provides the Tigers with new recruits, and second because the funds have come back. Seeing the disaster on television, overseas Tamils are once again sending huge sums home – some of which will doubtless be misappropriated by the Tigers.

To be sure, in both Indonesia and Sri Lanka, there is reason for hope. Consider the quake that struck Turkey in 1999 – it threatened to cause instability, but in the end, did much more to improve relations between Greece and Turkey by causing an outpouring of international sympathy. Natural disasters bring out the best in people as well as the worst. Especially if the international community stays closely involved, there is at least a chance that the political aftershocks of the tsunami, even in Indonesia and Sri Lanka, will be manageable.

All eyes are on Iraq’s upcoming elections as the test case for America’s plan to bring to democracy to the Middle East. But elections alone do not build stable democracies. The US is failing to learn from history – and missing an opportunity to put the stability of the Middle East on a firmer foundation.

In politics, it always matters who has the money, and in the Middle East, the wrong people have it. For decades the region’s political agenda has been set by oil-rich princes, tithe-rich ayatollahs, and aid-rich generals – to the detriment of both political openness and economic development.

It is not easy for outsiders to change this kind of politics, but it is possible. Consider the lessons learned in Japan. Recent books by Aaron Forsberg and Sayuri Shimizu have shown that it was not just Japanese industriousness and ingenuity that made post-war Japan such a success. It was the unusual form of US aid.

In Japan, as in Iraq, the early days were dark and difficult. Japan was economically devastated, politically authoritarian, and hopelessly exotic to its American occupiers. Two years into the occupation, Japan’s economy was stagnant and inflation was rising.

But then the Americans made an abrupt change of strategy. In 1948, National Security Council policy statement NSC 13/2 abandoned attempts to reform Japan’s politics and economy along US lines and made reviving Japan as a stable and prosperous anti-Communist ally the “primary goal” of US policy.

US funds poured into Japan, but not in the form of aid. During the decade surrounding the Korean War, the US military showered Japanese firms with supply and service contracts – in excess of $500 million each year; in some years close to $1 billion. In aggregate, this vastly exceeded the $2 billion in aid the US gave Japan’s government during the occupation. In 1952, a whopping 70 percent of Japan’s commercial exports were US military procurement orders.

The result was that in Japan, private businesses – not soldiers, politicians or priests – had all the money. And these businesses started to set the political agenda. In the 1950s, Japan’s firms lobbied their government for good infrastructure, a well-educated workforce – the things Japanese businesses needed to export to America’s newly opened, unimaginably wealthy, but highly competitive markets.

It is a political dynamic that is all too rare in the developing world. Japan’s elites lobbied for policies that would make not just them, but also their country, rich. In 1958, Japan’s three largest Japanese business associations colluded to pressure their government. But this was good pressure: their chief demand was an ongoing trade dialogue with America. In 1959 alone, Japan’s exports to the US grew by 52 percent. The country’s meteoric rise was under way.

To be sure, applying these lessons to the Middle East will be far from easy. But in the long term, it is this kind of politics – the politics of institutions and interest groups – that makes a country a success or a failure. Great leaders are both rare and temporary. Constitutions are mere pieces of paper until imbued with the weight of history.

A central goal of US policy in the Middle East should be to put money in the hands of the region’s private businesses. Efforts thus far have amounted to political window dressing. Halliburton, Bechtel, and other US contractors were instructed to farm out work to Iraqi and Middle Eastern subcontractors. But US firms, understandably, specialize in rebuilding power grids, not nurturing foreign industry. A watchdog group funded by George Soros found that, for 39 reconstruction contracts awarded in the past year, each with a value in excess of $5 million, only two percent of the revenues actually went to Iraqi companies.

No matter what, billions of US dollars have been spent in Iraq, and billions more will likely be required. The way to achieve the maximum policy impact with these funds is to distribute the benefits in the region. Reconstruction funds, including, as much as possible, military procurement, should go, first and foremost, to Middle Eastern firms. That will mean providing generous capital and technical assistance and relaxing standards and requirements. But that is the way to change who has the money in the Middle East, and create an interest group – outward-looking private businesses – that could at long last change the dynamics of the region for the better.

[In 2005, this column will appear every other Tuesday. -Ed.]

“This young century will be liberty’s century. By promoting liberty abroad, we will build a safer world.” – US President George W. Bush

Something quite unusual happened when, following the November 2003 uprising known as the “Rose Revolution,” Georgia’s new president ascended the steps of parliament to deliver his inaugural address. He raised the European flag, twelve stars on a blue field, above his country’s parliament, declaring, “This, too, is the Georgian flag.”

It is a rare thing indeed when a liberated country raises any flag but its own. But this was not the first time that European ideals had inspired a movement for democracy. Nor would it be the last.

In the mid-1990s, Slovakia was drifting towards authoritarianism. President Vladimir Meciar had allied with the quasi-fascist Slovak National Party and passed laws weakening the power of parliament and the constitutional court. He then turned the secret service on opponents in the media, labor unions, and local government.

The European Union (EU) responded by announcing that Slovakia was the only one of the ten Eastern European applicants that was failing to meet the political criteria to join the union. With their European dream slipping away, Slovakia’s divided opposition rallied together. The 70 percent of Slovaks that favored EU membership lent genuine popular support. Meciar was thrown from office, his authoritarian policies reversed, checks and balances restored, the secret police brought to heel.

A similar movement has now gripped the Ukraine. Another authoritarian state, and another democracy movement with genuine popular backing. Viktor Yuschenko, the opposition leader, has rallied his supporters with a long-term, four-point plan for his country to join the EU. Yuschenko is a personal friend of Mikhail Saakashvilli, the leader of Georgia’s Rose Revolution, the man who raised the European flag.

Contrast these stories with the ongoing bloodshed in Iraq, and one has a powerful illustration of the point that Fareed Zakaria argued in his recent book, shortlisted for last year’s Gelber Prize in foreign relations. That is, elections are the trappings of democratic success but not its core. Just as important – perhaps more important – to the long-term success of any democracy is a commitment to liberalism, a commitment that must be enshrined in law, practice and the popular imagination.

It is possible, Zakaria pointed out, to have liberalism without democracy, and these countries can be successes. For example: in September of 1997, the editors of the Washington Post railed against repressive Chinese policies in a piece entitled, “Undoing Hong Kong’s Democracy.” Hong Kong, of course, is not, and has never been, a democracy. But it had the rule of law, protection of basic rights and freedoms – so many of the characteristics of successful democracies that, in the minds of the Post’s editors, it became one.

By contrast, there are good many countries where elections are held – technically, “democracies” – and yet, liberalism and stability are both so absent that to call them democratic seems a mistake. In such places, elections can actually undermine political stability, trading repression for anarchy. In 1997, Zakaria singled out Haiti and Sierra Leone as particularly troubling cases. This was prescient. Haiti has since imploded, requiring US intervention to restore order, and Sierra Leone descended into civil war.

Elections encourage mass political competition, and in illiberal places, this may be no good thing. Iraq’s Sunnis are certain they will lose this competition, and that the government that wins will fail to uphold their rights. So they have turned to violence. It is democracy, but profoundly unstable. As is often pointed out, elections held tomorrow in Saudi Arabia are more likely to bring to power Osama bin Laden, or someone like him, than any liberal democrat. In short, “promoting liberty abroad” – in practice, promoting elections abroad – is highly unlikely to produce a “safer world.” This policy confuses the most obvious trappings of democracy with the underlying commitment to liberalism that has created open and stable politics in the west.

But is this a fair criticism of US policy? Surely promoting genuine liberalism in authoritarian places is little more than a pipe dream?

One could well argue this point, were it not for the stunning success of the European project. The European Union has brought liberalism to the illiberal parts of the continent in waves: first Italy, Germany, Spain; then Slovakia, Lithuania, Hungary; today Georgia, Turkey and the Ukraine. Each step in the EU accession process builds liberalism in law and practice. The 80,000 pages of standards and norms that EU applicants must ratify are, to be sure, European over-regulation taken to the extreme. But these also put into place the rule of law and the myriad, mundane checks and balances that put open politics on a stable footing. Moreover, each EU success story grips the popular imagination in neighboring countries and builds political support for liberalism at home.

This is, to be sure, no guarantee of success for Viktor Yuschenko in the Ukraine. His country is genuinely divided, and those in the east favor union with Russia over Europe. But divided or not, liberalism has gained the kind of popular commitment that can create, in the long run, genuine stability.

When the Ukraine’s elections were rigged, the opposition held peaceful protests in Kiev until an agreement on new elections was reached. Ukraine’s democracy was not working. A popular commitment to liberalism may yet make it work. That is democracy promotion done right. And what are the odds of such an outcome if elections go badly in Iraq?

The conventional wisdom has it that Mexico and China are engaged in an epic struggle which only one can survive. And it will not be Mexico. Mexico was – with its plentiful and cheap labor – the preferred workshop for America. But Chinese labor beats Mexican labor handily on both cost and plentitude, so the American factory jobs that had headed south are now heading east. China’s rise is Mexico’s fall.

There is some evidence to bear this out: over the period from 2001 to April 2004, according to A.T. Kearney, one of every four maquila manufacturing plants that had opened in Mexico – representing some 250,000 jobs in all – were shut down. And of the plants that were shut down, approximately one in three reportedly moved to China.

But this explanation for Mexico’s woes makes little sense, as trade is not a zero-sum game. After all, the jobs that moved from the US to Mexico did not cause the US economy to crash. And the US, despite competition from both Mexico and China, remains one of the world’s top investment destinations. Perhaps one could claim that China ought to displace Mexico at the top of the FDI attractiveness rankings. But Mexico fell 19 places in a single year. Something more fundamental must be wrong.

That something else has its roots in Mexico’s colonial history. The Spanish colonial regime in Mexico was established with the express purpose of enriching a few privileged Spaniards. “Economic life [in the colonial era] was organized by highly detailed and particularistic provisions, aimed at granting a complex web of privileges and monopolies,” writes Raymond Vernon, an economic historian. As time went on, an elite group of Mexicans also came to benefit from this system.

And then, in one of history’s great ironies, these rich Mexicans led a rebellion against Spain. The goal was to protect their colonial privileges, which were in danger of being swept away by a program of economic liberalization backed by the Spanish crown. “Mexican independence came through a virtual coup d’état by the colony’s Creole elite, carried out largely to separate Mexico from the liberalizing process under way in the Mother country,” writes John Coatsworth, another historian.

Thus Mexico came into independence as a country ruled by and for a rich elite. Its laws and government were created and preserved with precisely this goal in mind. Much has transpired in Mexico since then – including foreign invasions and a political revolution. But such privileges die hard and each successive generation of reformers has found it hard to put truly equitable institutions in place. A recent paper by James Robinson, for instance, makes the comparison between turn-of-the-century Mexico and modern Russia. Even President Porfirio Diaz – who ruled Mexico almost continuously from 1876 to 1910 – inadvertently created a class of “oligarchs” while struggling to reform Mexico’s elite-dominated economy.

To this day, an elite group of industrialists benefits from a system of law and government that favors their interests, and fails to protect the economic rights of most Mexicans. The result is that while Mexico is now officially a member of the OECD, the club of rich countries, its institutions protecting contracts and property continue to rank among the world’s poorest. The World Bank’s rule-of-law ratings put Mexico just above 50 on a 100-point scale – worse than Ghana, India and even Egypt. On the World Economic Forum’s survey of property rights and contract protections, Mexico ranks a dismal 62nd out of 80 countries.

And this is Mexico’s fundamental problem. Without sound economic institutions, the country is unable to take advantage of the investment it has received. Maquila plants on the Texas border have failed to turn into higher value added manufacturing. NAFTA should have propelled Mexican growth; instead, it has had little impact. The World Bank initially estimated that the first ten years of NAFTA had produced at least some net positive impact – perhaps 0.6 percentage points added to Mexican growth – but this estimate was subsequently revised downward.

In the final analysis, neither NAFTA nor competition from China are the major determinant of Mexico’s economic performance. Trade is an opportunity, not a guarantee. Mexico’s economic institutions – sufficient for the immediate postwar era, perhaps – have been insufficient to turn the country into the sophisticated OECD economy it claims to be. For broad-based and higher value added growth, Mexico will need sound economic law and equitable enforcement.

Indonesia was always different. Most of the Asian crisis victims – Thailand, Malaysia, South Korea – suffered sharp cutoffs in foreign lending, but investment dollars generally stayed put. Indonesia, by contrast, experienced spectacular capital flight.

Not at first. In the first two quarters of the crisis, inflows continued. And then, in three disastrous months in 1998, over $5 billion in equity capital fled the country. And in following months, more of the same.

What happened? The answer is that in May 1998, Indonesians set upon their ethnic Chinese countrymen in an orgy of violence that claimed over 1,000 lives. The Chinese were hated for their wealth. Though four percent of the population, they controlled an estimated sixty percent of the country’s assets.

And at that point, all these assets were sent offshore. Estimates of total capital flight top $20 billion. This triggered an economic meltdown far messier than anywhere else in Asia. South Korea, Malaysia and Thailand bounced back. But foreign direct investment into Indonesia actually turned negative and stayed that way into the new millennium.

So will Indonesia rebound? The odds are long. To be sure, Indonesia has just accomplished something extraordinary. The world’s largest majority-Muslim country has become a genuine democracy. The incumbent candidate, competent but uninspiring, lost to a secular challenger with a reform agenda. The Islamic parties that did best in the vote uniformly stuck to a moderate, clean-government agenda. Radical Islam was on offer but unpopular. And the campaign itself was peaceful. The voting carried off without a hitch; the results not seriously disputed.

On top of this, Indonesia turned a decades-long tradition of dictatorial presidency on its head. Not only did the incumbent lose, but between 1999 and 2003 a series of constitutional amendments introduced genuine checks and balances into the system. Including the devolution of power to the provinces, legislative reform, and a new – and evidently quite functional – electoral process.

Still, democracy is one thing. A rebound to previous performance – growth of over seven percent per year between 1970 and 1996 – is quite another. Thailand, South Korea and Malaysia have gotten close. But Indonesia is unlikely to join them.

The reason is that the bargains which made Indonesia work died in those riots, along with hundreds of Chinese. Suharto’s dictatorial authority was crucial to enforce the policies of his “Berkley Mafia,” the University of California-trained technocrats who made Indonesia safe for investment. Without this, Indonesia’s 6,000 islands have each gone their own way. Most notably, local courts, susceptible to local influence, have attacked investors. The most notorious case is that of the Indonesian arm of the multinational insurer Prudential, absurdly forced into bankruptcy.

Also crucial was Suharto’s relationship to the ethnic Chinese. Suharto cultivated ethnic Chinese businessmen as allies, enriching them with state favoritism, and they reciprocated with political support. They were ideal cronies: captains of industry who – because of their status as a hated minority – could never develop political ambitions of their own, and relied on Suharto for protection. (Suharto, who had deposed his mentor in a military coup, knew the difficulty of finding reliable allies.)

These crucial conditions of Indonesia’s boom years will never be restored. Some of the ethnic Chinese capital will return but – with the Chinese leery and no dictatorial protections on offer – Indonesian industry will need new leaders. The just-elected president, Susilo Bambang Yudhoyono, has won a substantial mandate, but he will be no Suharto-style dictator. His party has only 57 seats in the 550-seat parliament, and the two largest parties backed his opponent.

This is, in a sense, a great achievement. That the largest parties lost to an independent candidate reveals a determination to move on from the cronyism of the Suharto years. Throwing out an incumbent, peacefully, is the true test of a democracy – even Japan did not achieve this until the 1990s, fully forty years after it became “democratic” following World War II.

On the other hand, the system for protecting capital and nurturing growth that made Indonesia a star emerging market has also collapsed. Achieving that level of performance in the new Indonesia will not be easy. With power decentralized, the system itself must be made to work – the rule of law, protection of property, control of corruption. Indonesia is a true democracy now, but it is a long, hard, and, odds are, slow road that lies ahead.

[The Editor is on leave to finish a new book. Editorials will resume in mid-November.]

“Municipal officials in Guangdong Province were informed that (to save farmland lost to burial plots) the proportion of cadavers cremated would be designated a Key Performance Indicator and tied to compensation.” – Holding China Together, page 24.

William Greider called China a “black box” in which one can find ample proof for just about any expectation. To see the truth in this look no further than the recent China literature, divided into two opposing and indeed contradictory camps.

On the one side are books like William Overholt’s The Rise of China or Ross Terrill’s The New Chinese Empire. In such books China is a coming political and economic superpower – indeed, the main threat to US global dominance and perhaps even US security. (To wit: China Attacks.)

On the other side is Gordan Chang’s The Coming Collapse of China. And academic works such as The Chinese Economy in Crisis and China Deconstructs. In this alternate universe, the “China threat” comes not from the country’s rising military power, but from the likelihood of an Indonesia-style meltdown or unmanageable political disintegration.

In a new book, Holding China Together, Barry Naughton and Dali Yang open the lid on the black box of Chinese politics. The result is sometimes dull – an endless barrage of statistics and detail. But, in contrast to the hysteria of China forecasts made via anecdote, this book reveals the hidden mechanisms by which Chinese politics actually works.

What quickly emerges is that the horror stories from the “China disintegrates” camp are not wholly without merit. The end of communist central control often creates a vacuum in which destructive forces thrive. Witness the political collapse of the former Yugoslavia; or the economic collapse of Russia.

No less in China. Economic liberalization caused the Chinese government to lose control of the country’s economy. The central government’s tax take fell from 40 percent of national output in the 1980s to 11 percent by 1995. Not due to tax cuts – even in famously tax-averse America, the tax share of GDP is 23 percent – but because the central government was losing its grip. Finance Minister Liu Zhongli sounded the alarm: “when the government does not have money, its words no longer count.”

Just as in Russia, declining central control revealed citizens’ capacity for greed. Corruption is always hidden and hard to document. But a clever reading of Chinese statistics reveals some shocking examples. In Shanxi Province, “energy fund” fees of some 280 million yuan were levied on coal exports. But official records reveal only 15 million yuan was actually collected. An astonishing 95 percent of the revenues went missing thanks to official corruption.

Facing dysfunction on that scale, how did China survive? The answer, the scholars in the book contend, is that the Communist Party maintained its integrity and control. Not through charismatic leadership or high-profile official doctrine – which is why trying to read the tea leaves of China’s leadership struggles provides so little insight. But rather, through a robust personnel management system, operating everywhere and always behind the scenes.

This may seem unglamorous. But it is also effective. Although the Communist Party, Chinese government, and People’s Congresses are officially separate, in practice, the Communists retained control over almost all government hiring and promotion.

This gave the Party a powerful tool to counter the threat of disintegration. When economic liberalization threatened to undermine central control, the Party created an elaborate transfer system to prevent any provinces from getting out of line. Scholar Zhiyue Bo documents sixty-nine cases of transfers of top-level provincial leaders between 1990 and 2002 – roughly the equivalent of the US president stepping in to swap the governor of Illinois for the governor of Michigan. Odd, but an effective means of nipping in the bud any single province’s growing political clout.

The Party also created an elaborate set of performance indicators and rewards. For instance, local Party leaders were evaluated on whether they had increased grain output, added infrastructure, and kept down population growth. Township governments were evaluated on increases in industrial profits, increasing sales of pigs, building more Party organizations, and maintaining public order, among other factors.

And the rewards for good performance were substantial. Susan Whiting finds that in Songjiang County, the Party leaders of the best-run town had salaries that were 66 percent higher than the worst-performing towns. Near Shanghai, she unearths the case of a village Party secretary who presided over an output decline and had his income docked from 6,000 yuan to 2,950.

Holding China Together documents another means of central control, also understated but also crucial. That is, institutional change. Fubing Su records the repeated failure of efforts by Beijing officials to shut down small coal mines to reduce excess coal production. Local officials, protecting their local mines, would go so far as to dynamite the mines shut when Beijing’s inspectors arrived and then dig them out again as soon as the inspectors departed. Beijing finally solved the problem by reclassifying revenue from large national mines as local revenue, giving local officials the incentive to protect the large mines instead of the small ones.

As the details add up, it becomes clear that those worrying about a disintegrating China can relax. The mechanisms of government are unspectacular but they work, a story told again and again across provinces and industries. Even in the chaos of the mid-1990s, there was little real cause for alarm regarding China’s political unity.

But Holding China Together is less reassuring on another question: the country’s economic stability. Dali Yang documents a sophisticated remaking of the central bank in his chapter on economic governance. And he and Yanzhong Huang examine cross-province data and show that as China’s bureaucracy becomes more sophisticated, it is able to take a more nuanced route to achieving the center’s goals – in this case, population control.

But what emerges again and again in the book is that China’s economy is spectacularly politicized. Economic problems often result from local Party officials disobeying the center; and these problems are solved by political means – new performance targets, for example, or altering political institutions.

To be sure, the Party has not slipped up yet. China sailed through the Asian financial crisis unscathed. But when the economy hits a true rough patch, are inherently clumsy political responses – Susan Whiting dubs them “high-powered incentives” – going to make the country’s economic problems better or worse? China is holding together. Whether it will stay on course remains to be seen.

[Holding China Together is now available from Amazon. As is Dali Yang’s other new book, Remaking the Chinese Leviathan: Market Transition and the Politics of Governance in China. And, Editorials will be on vacation next week. – Ed.]

[Corrected 9/13/04]

The Panelists:
Helmut Norpoth (SUNY Stony Brook)
Brad Lockerbie (Univ. of Georgia)
Thomas Holbrook (UW Milwaukee)
Christopher Wlezien (Oxford) with Robert Erikson (Columbia)
Alan Abramowitz (Emory)
Michael Lewis-Beck (Univ. of Iowa) with Charles Tien (CUNY Hunter)
Moderator: James Campbell (SUNY Buffalo)

“This will not be a ‘girly man’ forecast,” says the moderator. And it isn’t. Helmut Norpoth towers over the podium, grips the edges with meaty hands, the microphone reaching only just above his navel. “Bush wins with 54.7 percent of the popular vote,” he thunders, in a distinct German accent.

This being academia, bold forecasts, and even accurate forecasts, aren’t all that matters. Norpoth is certainly bold. He made his forecast back in January and hasn’t changed it.

Bold, but is it justified? All the panelists make their predictions based on statistical models of voting behavior, back-tested on data from previous elections. But not just any data. If blue-eyed candidates always beat candidates from Texas, that won’t cut it. There must be a sound theoretical basis for each model’s explanation of why Americans vote the way they do.

“The best way to predict an election is with an election,” Norpoth says, defending his approach. Most of the models include some measure of the economy – reflecting, loosely, the idea that people vote their pocketbooks. (“It’s the economy, stupid.”) Norpoth’s model is based mostly on a sophisticated reading of the New Hampshire primary results. Which is why he calculated, back in January, a 95 percent chance of a Bush win. (Bush was nearly unchallenged in New Hampshire; Kerry had a bit of a fight.)

As the Republic Convention finishes, though, Norpoth is nervous. The polls aren’t where he’d think they’d be. Likewise for Brad Lockerbie. His model, based on surveys of consumer finances, has Bush winning with a landslide 57.6 percent.

Say these scholars are far wrong. What would that mean? First of all, it would be improbable. Perhaps surprisingly – given the unpredictable nature of US politics – most of the models produce a median forecasting error of only two percent of the popular vote in past elections. That’s pretty good. (Norpoth’s model accurately picks the winner in every presidential election since 1912 except one, 1960.)

Historically, pre-convention opinion polls have been about five percent off the final vote, on average. Post-convention polls are four percent off. And the final Gallup poll, on the eve of the election, is, on average, still 2.1 percent off the actual results. Many of the panelists’ models exceed this level of accuracy, using data released months before the vote.

Impressive, but that doesn’t make them error-free. The 2000 election was so close it wasn’t decided by the popular vote. (That job was, infamously, left to the Electoral College, Florida officials, and the Supreme Court.)

So not everything is predictable. But the assembled scholars believe most of the variance in the popular vote is explainable, based on sound theory.

Alan Abramowitz, for his part, plays up the theory. He’s annoyed by a recent New York Times Magazine article on economist Ray Fair, who has a model of his own. Abramowitz isn’t buying it. “It’s not an economic model. He tweaked it. He put a ‘time for a change’ variable in there, he doesn’t tell you about that. That’s my variable. I thought of it.”

‘Time for a change’ reflects a penalty that grows the longer a party holds the presidency. Bush the elder was a victim in 1992, because the Republicans at that point had been in office for 12 years. For Bush the younger, it’s no threat, so based on the economy and his approval ratings, Bush should win handily, says Abramowitz.

And there’s reason to believe this. Most of the models are new this year, but Abramowitz has been running his model since 1988, and he’s picked the correct popular vote winner every time.

Indeed, what makes this year’s election so interesting is that almost every model predicts an easy Bush victory. Thomas Holbrook’s approach based on approval ratings; Brad Lockerbie’s equation based on prospective personal finances; and Norpoth’s numbers from the primaries – all have the odds of a Bush win at more than 90 percent. Christopher Wlezien and Robert Erikson are only slightly less certain. A 75 percent chance, they say.

In other words, this shouldn’t be a repeat of 2000 – where models that were right about the vote were wrong about the outcome. If decades of history are any guide, Bush should be far ahead. That he isn’t is puzzling. A professor in the audience stands up and shouts: “if it wasn’t for this unilateral war Bush would be winning by a landslide!”

Or maybe there’s another explanation. Michael Lewis-Beck is a respected scholar in the field, but his 2000 model was far off. So he scrapped it and, with Charles Tien, created a new version for 2004.

This new model is a little odd. He’s using a standard economy measure, but then adjusting it by one-half if there’s a ruling party candidate who’s not the incumbent. And then another adjustment in cases where the incumbent “doesn’t like” the candidate from his party. By this point, Abramowitz, the stickler for theory, is clearly fidgeting.

By the time Lewis-Beck adds in his fifth variable, Abramowitz is rolling his eyes. But Lewis-Beck’s model is the most accurate, on past data, of any of them – an R-squared of .96, for statistics buffs.

And for this year’s election, because of dismal jobs growth, the Lewis-Beck model predicts a close race. Essentially a tie in the popular vote. Which means it could go either way. Indeed, he pulls out a chart which, he claims, shows that the race will go the Electoral College and then resolve in Kerry’s favor. By this point the other panelists, who are overwhelmingly Democrats and no doubt want to believe him, are nonetheless voicing loud theoretical objections.

It seems that devotion to theory trumps party loyalty. The moderator, the lone Republican on the panel, chuckles into the open mike. He says: “face it, it’s time the Democrats took one for science!”

“The United States has not posted an ambassador to Equatorial Guinea since 1994, a year after the last one, John E. Bennet, was accused of practicing witchcraft.” – The Washington Post, May 2001.

Equatorial Guinea is one of those rare cases in which the discovery of oil has not made the country’s politics worse. Because that would have been all but impossible. Equatorial Guinea’s government already existed in a state of near-total dysfunction.

The country’s paralyzed bureaucracy, ridden with corruption, fails to provide basic health and sanitation services to most of the population. To such an extent that average life expectancy, in what is now one of Africa’s richer nations, is about 55 years. Worse than Cambodia and Sudan; about on par with Laos.

As colonies go, Equatorial Guinea was fairly well-off as of the 1950s, under Spanish rule. It was an unlikely country, though. A collection of islands, the largest of which, Bioko, is actually off the coast of Cameroon – plus a random patch of West African coastline. All located due south of Nigeria. The first post-independence president, Francisco Macias Nguema, afflicted by madness or ignorance, unleashed a campaign of terror that led to the death or exile of an estimated third of the population. Under his misrule the capacity of the state to do anything – much less maintain infrastructure or provide health care – diminished nearly to nothing.

Macias was overthrown and executed by his nephew, Obiang, in 1979, not before time. This resulted in genuine improvements – education restarted, World Bank advisors invited in. But spectacular corruption continued and Obiang’s rule was far from democratic. Opposition leaders were arrested and tortured, and Obiang won sham elections with 97 percent of the vote.

So what attracted Sir Mark Thatcher, son of Margaret, to involvement with this unfortunate country? That is no mystery. In 1995, oil was discovered. Equatorial Guinea’s economy expanded by a staggering 1500 percent in a few short years. Oil production leapt from next to nothing to 350,000 barrels per day.

At this point Equatorial Guinea’s position became somewhat precarious. The tiny, dysfunctional country’s survival had been predicated on the fact that it was uninteresting. But with oil, this changed. Mercenaries tried to invade in 1997; separatists attempted a rebellion in 1998; then a coup attempt in 2002. Obiang put these down with relentless brutality and the help of some well-armed foreign bodyguards.

But in 2004 an aging group of mercenaries – many of them veterans of Executive Outcomes, the infamous mercenary firm which fought civil wars on behalf of oil-rich regimes in Sierra Leone and Angola – gathered in South Africa for the proverbial “one last job.” This was to depose the government of Equatorial Guinea, in exchange for cash and oil contracts. An opposition leader, Severo Moto, in exile in Madrid, would take power. Obiang would be flown to Spain.

But it all went spectacularly wrong. Most notably the plotters seemed not to understand that the government of South Africa – in the days of apartheid sympathetic to such adventures – now sought stability in Africa. The mercenaries were arrested, variously in Equatorial Guinea, South Africa and Zimbabwe.

And they began to talk. For this credit partly the Equatoguinean government’s use of torture – one of the mercenaries in its custody has already died, in disputed circumstances. South African police arrested Thatcher on suspicion of being one of the plot’s financiers.

An unhealthy attraction to be sure. And one that is not limited to aging mercenaries. In the past, the United States took a strong stand against Equatorial Guinea’s authoritarianism and kleptocracy. In the early 1990s the US ambassador criticized the government’s human rights record. He was formally accused – literally – of practicing witchcraft and told to leave the country. In one of those rare examples of backbone that makes one proud of the Foreign Service, he used his farewell address to name the government’s most notorious torturers.

But all that has changed. The first oil in Equatorial Guinea was discovered by Mobil. Marathon and Amerada Hess, also American companies, are now in the country. Suddenly, the United States has rediscovered a “positive, constructive” relationship with Equatorial Guinea. Though there is little improvement in the human rights situation.

This is surely yet another unhealthy attraction. It is a failure to learn the bitter lessons of the Middle East, where US support for despotic oil-rich regimes in Iran and Saudi Arabia helped create an implacable enemy and Islamic terror, respectively.

At the very least it is a failure to learn the lessons of Nigeria, only a short hop to the north. There, in the Niger Delta, oil-fueled ethnic violence rages with such force it has stopped oil production repeatedly in recent years. Surely these are experiences that America and its oil companies ought to be in no hurry to replicate. As a new source of supply, Equatorial Guinea is attractive. But this blossoming relationship, on current terms, is, in the long run, unlikely to do any of the parties much good.

[Want more on Equatorial Guinea? Robert Klitgaard’s Tropical Gangsters, perhaps the best book ever written on what it’s really like to attempt to aid a dysfunctional country, just happens to be set there. – Ed.]

“Venezuela…is heading in the same direction, toward the same sea to which the Cuban people are heading: a sea of happiness.” – Venezuelan President Hugo Chavez.

There was a time when one reasonably might have expected never again to hear Cuba, with its authoritarian politics and dysfunctional economy, invoked as a model for anything. But Chavez is not as lunatic as he sounds. There is a logic to his rhetoric, a logic dictated by politics. And it bodes ill for Venezuela.

Chavez’s politics are above all the politics of charismatic populism. They are the politics of popular protest – the only kind of politics that worked in 1990s Venezuela. Chavez’s problem was something called the “Punto Fijo system.” This system was born in 1958, in the town of Punto Fijo, when Venezuela’s two leading political parties inked an agreement to share power no matter what the results of the 1959 election.

It started as a compromise to stave off civil war; but it fostered unhealthy collusion. The two parties, always sharing power, grew fat on decades of uncontested control of state spending. By the early 1990s, the Punto Fijo patronage network was so vast that more Venezuelan towns had party branch offices than had Catholic churches. The only political candidates with any chance of success were Punto Fijo candidates.

Chavez changed that. He found the beast’s soft underbelly. To defeat the professional politicians, propel the masses into politics. This he did with fiery rhetoric. “So much riches—the largest petroleum reserves in the world, the fifth-largest reserves of gas…and 80 percent of our people live in poverty. What scientist can explain this?” Chavez claimed that Venezuela’s great wealth had disappeared into the pockets of the country’s “political class.”

And the people believed him, to an astonishing degree. Opinion polls found 91 percent of Venezuelans agreeing that corruption was the only factor preventing all Venezuelans from living “very well.” A full 78 percent of respondents believed that Venezuela was “one of the richest nations in the world.”

Chavez had identified the source of Venezuela’s problems. And the solution: topple Punto Fijo. In the 1998 presidential election, hitherto passive Venezuelans made themselves heard. Voter turnout leapt from the 30 percent average to a staggering 95 percent. Chavez won a landslide victory. And then, with roaring supporters in the streets, he dissolved the legislature and imposed a new constitution via referendum.

But Chavez had a problem. What he had said was not true. Venezuela was not, in fact, rich. Truly oil-rich states such as the United Arab Emirates and Kuwait have per-capita oil revenues in excess of $9,000 per annum. Venezuela’s hover around $330.

Scholar Kurt Weyland wrote a perceptive article in 2001 arguing that unlike relatively successful Latin populists such as Alberto Fujimori in Peru and Carlos Menem in Argentina, Chavez was headed for a quick demise. The problems of both Argentina and Peru – hyperinflation in both cases and, in Peru, unchecked guerillas – were amenable to dramatic remedies. Fujimori and Menem took bold steps producing quick results and cemented their popularity. But Venezuela’s problems – entrenched poverty borne of economic failure – would take decades, not months, to fix.

To be sure, Chavez had to some extent fingered the right villain. The Punto Fijo system nurtured a public sector that was a political patronage mechanism, not a functioning civil service, and class of business “oligarchs” with excessive political influence. (Like the oligarchs in Russia, they controlled much of the media and abused this to political ends.) The pernicious influence of these entrenched interest groups indeed helped keep Venezuelans poor.

In fact it is astonishing just how poorly Venezuela ranks in the annual economic competitiveness surveys produced by the WEF and IMD. With its dysfunctional civil service, Venezuela ranks either worst or second-worst of all rated countries on (1) the competence of public officials, (2) the frequency of bribes, (3) the degree of judicial independence, (4) the quality of the legal framework, (5) political interference in the civil service, (6) protection of private property and (7) the basic ease of doing business. Which is to say, on these measures, rated as bad or worse than countries including Bangladesh, Nigeria, Vietnam, Ukraine and Haiti.

But such profound institutional problems are not amenable to quick, dramatic improvements. Or so Weyland argued in his 2001 article.

But Weyland had overlooked one important ideology – one so discredited it had fallen off the map in most of the world – Cuban socialism. And this offered quick and dramatic solutions – to at least the symptoms, if not the cause, of Venezuelan poverty. If wealth could not be created, at least it could be redistributed.

And so when, as Weyland had forecast, Chavez’s popularity plummeted – to under 30 percent by 2002 – Chavez did not give up. Rather, he tightened his improbable embrace of Castronomics. He handed out oil money to the poor via social programs. And – in exchange for the oil to feed his dying economy – Castro sent an army of doctors to man public clinics in the Venezuelan slums.

These were the bold strokes Chavez needed. His popularity rebounded. This month, he survived a recall referendum he had once looked sure to lose.

To be sure, Chavez probably has no intention of implementing full-on Cuban socialism. He seems in no hurry to destroy his country’s economy. Most economic instability thus far has been the result of Chavez’s running battle with Venezuela’s elites. Strikes that shut down the oil industry, exchange controls designed to punish businesses sympathetic to the opposition. With these fights winding down, the economy has, for now, rebounded.

But the problem is Chavez’s political logic. Robert Mugabe in Zimbabwe likely never planned the rapid forced redistribution of white-owned farms that has caused his country’s economic collapse. But he had talked about it so much that – his back against the wall – he was eventually forced into it.

And that is the dire fate that may well await Chavez. Communism is a card that, once played, does not go back in the deck easily. The more dramatic results Chavez is called upon to deliver, the greater the cost to the economy. (And then, the greater the clamor for more results.) Venezuela may indeed be heading in Cuba’s direction, whether the captain knows it or not – and in that direction, “a sea of happiness” is not what awaits.

1 / Very Low / 0 – 10 percent
2 / Low / 10 – 25 percent
3 / Moderate / 25 – 35 percent
4 / High / 35 – 45 percent
5 / Very High / 45 percent or more

- The Heritage Foundation’s scale for rating the severity of government intervention in the economy, based on the percentage of national output produced by state-owned firms.

The idea of state ownership triggers an almost physical revulsion in some economists. Each year the conservative Heritage Foundation releases their Index of Economic Freedom, invariably accompanied by research showing that countries with highly interventionist governments suffer dire economic consequences.

Of course, they can do this only by fiddling the data for Singapore. This was most pronounced in 2001. By the Heritage Foundation’s own scale, the country should have rated a five – “very high” intervention. As much as 60 percent of Singapore’s national output, Heritage noted, came from partially state-owned companies. Instead, Heritage scored Singapore at three – “moderate intervention.” Which was at least more realistic than the year before, when they rated the country, bizarrely, at two – “low intervention.”

But forgive the Heritage analysts a bit of ideologically-induced blindness. Singapore is a spectacular outlier. In 1959 it was a swamp plagued by tuberculosis and race riots and dotted by slums. Today it is richer than much of Europe. Not only is Singapore’s economy improbably state-dominated; its politics remain improbably undemocratic, despite the first-world levels of wealth and education enjoyed by Singaporeans.

It is always fashionable to predict that Singapore’s unlikely model is about to break down. Authoritarian politics and state-dominated economics are unloved by commentators on both the left and the right. And yet, even as power passes to Lee Hsien Loong, son of the country’s first prime minister, Singapore has good odds of continued success.

The reason is that the model is still sound. To turn a swamp into a super-state in the space of forty years requires something unusual. Good policies, to be sure – while most countries pay lip service to the basics, such as education and infrastructure, Singapore’s first prime minister, Lee Kwan Yew, poured money into them. During the first nine years of his administration, an incredible one-third of the budget went to education.

But what made Singapore truly exceptional was the civil service. Lee created a bureaucracy of ruthless competence. In many developing countries, public sector jobs are a patronage mechanism – they may not pay well, but offer ample opportunities to collect bribes, and hence can be created and distributed to political supporters in great numbers at little cost to the budget.

Lee’s service was different. The jobs would be extremely well paid – salaries of Singapore’s top civil-servants are explicitly pegged to those of private-sector CEOs. So the best and the brightest would come. And only the best would be hired, through a rigorous examination system. “An extreme example of meritocracy,” in the words of one scholar. Corruption would be ruthlessly punished. So much so that according to Transparency International, Singapore now ranks among the least corrupt countries on earth – trailing only Finland, Denmark, New Zealand and Iceland. And well ahead of the United States.

And then this civil service would be placed at the center of everything. To this day, 75 percent of Singaporeans live in government-built housing, and government-linked firms account, by some measures, for the majority of economic activity.

Fans of free markets may object that such a command and control economy could never rival the great capitalist centers as an innovation machine. But that was never the idea. The civil service would be employed to create the ideal business environment – the absence of corruption, the superb infrastructure. The government-linked companies were established in support industries such as shipbuilding and repair (Keppel and Jurong), transport (Orient Lines and Singapore Airlines), and infrastructure (Singapore Telecom). They provided joint venture partners for foreign firms – for instance, Singapore Refining partnered with British Petroleum and Singapore Petrochemical with Shell, in the early years.

The idea was to attract the great innovators from abroad. And this worked. The foreign investors came in droves. The ratio of the value of foreign direct investment in Singapore to national output is over 140 percent, the third highest in the world if offshore tax havens are discounted. Even countries such as China – whose growth is often described as fueled by foreign investment – do not exceed 50 percent. For the US, the ratio of foreign investment to output is under 15 percent.

So those who criticize Singapore for its state-dominated economy, stifling innovation, and its risk-averse people misunderstand the model. The state is employed, not as an economic dynamo, but as the skilled technician that keeps the dynamo running. In the past decade Singapore has proved the model still works by attracting a venture capital industry and building biotechnology research.

There will, to be sure, be challenges. Singapore’s bureaucrats have been eager consumers of Richard Florida’s Rise of the Creative Class, which argues that creativity drives rich-world economies. One of Florida’s contentions is that highly creative places have large gay populations. In 2003 Singapore’s pragmatic bureaucrats duly announced that homosexuals would be welcome in the civil service. But this is a small step, in a highly conservative country that still has laws forbidding homosexual sex on the books.

Still, it would be wrong to think that Singapore’s model is in danger. The country’s program of recruiting “creative class” scientists has been successful in recent years. The Economist magazine recently reported several top biomedical researchers lured to Singapore to establish labs. And Pfizer and Schering-Plough expanding their capacity in the country. It may not be popular, but Singapore unusual state-led miracle is likely to be maintained.

“…drivers glide about…fueled by petrol that’s cheaper than water.” – The official magazine of Britain’s Royal Geographical Society describes life in Qatar, March 2004.

To say that in Qatar gasoline is cheaper than water is not technically accurate. For Qataris, water is free – so are electricity and health care, and there are no taxes – while gasoline is highly subsidized but still costs a few pennies per gallon.

Yet the Royal Geographic Society’s claim captures the flavor of the place rather well. A country of such extremes that the immutable laws of political economy bend and bend and finally begin to run in reverse.

Start with the extremes of population and provenance. Qatar – bordering Saudi Arabia, and pronounced, roughly, “cutter” – has only 150,000 citizens and yet possesses sufficient natural gas reserves to heat every home in America for the next 100 years. And that is before the oil reserves – also large – are even counted. Which makes Qataris, before they lift a finger, some of the richest people on earth. (In 2000, according to United Nations statistics, they were, in fact, the richest – it depends on oil prices.)

With only 150,000 people, this is more a family than a country. And that is not far from the literal truth. An estimated one-fifth to one-half of Qatari citizens have royal blood. When the Al Thani clan fled there after losing one too many battles for control of Arabia, Qatar was a desolate, arid peninsula jutting out into the Persian Gulf. Hence there was no indigenous merchant class to deal with. No political, religious or business groups to struggle with or co-opt. The Al Thani family built the place from scratch.

And once the oil started flowing, they could afford some hired hands to help with the job. So many, in fact, that Qataris have now become a minority in their own country. There are an estimated 600,000 migrant workers – Indians, Pakistanis, Filipinos – serving as guest laborers in Qatar.

What happens to politics when a majority of the population – the guest workers – are almost completely apolitical? When nearly all political and business leaders and indeed much of the general public come from the same family? When the economy booms continuously and almost without effort?

Suffice it to say that the normal rules do not apply. Qatar suffered no significant political instability from 1972 to 1995, despite the misguided, spendthrift and even kleptocratic policies of the former emir. (The Qatari government has politely asked him to return $3 billion in missing funds to the national treasury.) Policies that would have plunged a less fortunate nation into political and economic crisis did little more than run up the national debt. To this day, there is no discernable organized political opposition. It is even hard to detect much political protest.

What instability Qatar has suffered owes more to Shakespeare than Caesar. The current emir deposed his father in 1995; who for his part had deposed his uncle. The 1995 coup was bloodless. There was an attempt at a counter-coup, but that was more comical than alarming. Bedouin nomads, recruited for the job, infiltrated across the dunes from Saudi Arabia, but in the unfamiliar urban environment of the capital city became hopelessly lost and were unable to find the presidential palace.

It is almost as if categories such as “government” and “the people” do not apply. There is a strong political reform movement in Qatar, but it is being imposed by the country’s autocratic ruler on a public that seems frequently surprised and sometimes even opposed to democratization. (The rules of politics, once again, running in reverse.) The emir created elected business bodies, then elected municipal councils, and finally in April 2003 rammed through a referendum on a constitution that will create an elected parliament – albeit with limited powers.

On top of which the emir created Al Jazeera, the independent television network which has become the main outlet for all the ample political rage of the Middle East. This rage is directed against enemies both real and imagined, and Al Jazeera targets them all with its reporting and commentary. This includes, of course, Israel and the United States. But also Islamic regimes. It was Al Jazeera reporters who broke the story of the atrocities being perpetrated with the complicity of Sudan’s Islamist government in the now-infamous Darfur region.

Indeed, the only thing that worries Qatar is its neighbors. The Iraqi invasion of Kuwait drove home this point. With its vast wealth and tiny populace, Qatar is a tender morsel that the region’s big cats – Iran, Iraq and even Saudi Arabia – have all eyed hungrily.

And this, in the end, explains why Qatar – and Al Jazeera, and the “Doha Round” of trade talks – have recently made the front pages. If the past year has shown anything it is that Middle Easterners have long memories. Much of the Middle East recalls injustices perpetrated by foreign occupiers. But Qatar, by contrast, exists today only because Britain saved it from annexation by the Saudis in the early 1900s. The Al Thani family has not forgotten this, and reaches out to the outside world whenever it can. US bases, world trade talks and the 2006 Asian Games – Qatar is hosting all of these in an effort to cultivate foreign friends.

And in recent years the outside world has reciprocated, resulting in the current Qatar boom. Qatar may not have as much oil as Saudi Arabia or Iraq, or the strategic importance of Egypt. But with its combination of spectacular wealth, a tiny population, and amiable politics, Qatar is well-supplied with a commodity that, in today’s Middle East, has become even more precious than oil. That is, political stability. Hence on the world stage, Qatar’s 150,000 citizens punch well above their weight.

“It is hard to overstate the importance of Pakistan in the struggle against Islamic terrorism.” - Report of the 9/11 Commission on Terrorist Attacks upon the United States.

When the 9/11 Commission consulted counter-terrorism experts on where they most feared terrorists would today establish bases, “western Pakistan” topped the list. The Commission also raised the alarm about Pakistan’s madrassahs, Islamic schools where many of Al Qaeda’s footsoldiers were indoctrinated. And decried the fact that a leading Pakistani nuclear scientist had run a nuclear smuggling ring, selling atomic secrets to Iran and North Korea, among others.

As to why Pakistan – the recipient of close to $50 billion in foreign aid, and for decades a US ally – should be such a threat, the Commission had this to say: “poverty, widespread corruption, and an often ineffective government.” But surely there is more to it than that. Those labels fit many countries, few of which are distributing nuclear secrets or educating terrorists.

To understand what makes Pakistan the hardest of the hard cases, recall an obscure tragedy that took place in the province of Punjab many decades ago. There, well-meaning politicians, noting the huge numbers of impoverished peasants, decided it would be a good idea to redistribute some of the unused landholdings of the province’s wealthiest landlords to peasant families. The landlords did not think much of the idea. The politicians insisted. The landlords simultaneously withdrew their produce from the region’s markets, creating a man-made famine. The politicians backed down.

This story is important because Pakistan does not have any of the usual problems of so-called “failing states.” No civil wars, no communism, no Islamic regime, and even – for about half the country’s history – a genuine democracy. Pakistan is in a class by itself.

The root of the country’s problems is special interest politics, elevated to the level at which it causes political dysfunction.

Much of the blame for this falls, oddly enough, on the British. It was not their intention to foment a long-running disaster. But the British had a problem in their colonial domains: a huge and uninteresting region of northern India that would require immense military and administrative investment just to keep the peace. So the British decided to shake up local politics. They granted the region’s nobles vast landholdings and absolute power over their lands, as long as they maintained order among the peasants who lived there.

From the colonial point of view, a great success. Empire on the cheap. But the assets of a successful colony are the liabilities of an independent country. India gained independence from Britain; and then Pakistan from India. And the new country was utterly dominated by this landlord class. (The Pakistanis call them “feudals.”) To this day, the feudals – five percent of agricultural households – between them own 64 percent of Pakistan’s farmland. In 1997, the top 800,000 families alone owned 11 million acres.

But what is really sinister about this not the inequity, it is the politics. The landlords have nearly absolute economic power over the peasants who work their land. The landlords allow sharecroppers, called haris, to till the soil. On top of this, the landlords usually provide the loans for seeds and equipment that keep the haris in operation. (But also prevent the haris from ever improving their lot – the loans are at punitive rates, and the haris are usually forced to pay half their income as tribute.) So the ever-impoverished haris live at their landlord’s mercy. At any moment, they could be thrown from the land with little hope of survival.

This gives the feudals, in essence, a cadre of political supporters who dare not disobey orders. During elections, that means the feudals can deliver the votes. From 1947 to 1970, a full 75 percent of the members of Pakistan’s parliament were feudal landlords. In the National Assembly dissolved by General Pervez Musharraf’s 1999 military coup, feudals and tribal leaders held the majority of the seats.

When democracy falters, the feudals are just as powerful. They have the money to buy influence and reward support. Indeed at least two of Pakistan’s military coups were undertaken with strong backing by the feudals. In 1953 Khawaja Nazimuddin was deposed after he attempted to break up feudal estates. In the 1970s Zulfiqar Ali Bhutto was overthrown and hung after he passed one too many land reform laws. (The military dictatorship then reversed his reforms.)

That the feudals have such great political influence seems unjust. But it is far worse than that. Consider, for a moment, the self-interest of a medieval landlord. The feudals’ wealth and power is based, in the first instance, on the exploitation of landless peasants. So what is the worst-case scenario, from a feudal’s point of view? Anything that improves the peasants’ lot – education, land reform, economic opportunity, legal protections.

And that is Pakistan’s dysfunctional formula: a powerful political elite actively opposed to development.

Education, security, rule of law – these are the services of government. And with no desire for these services, the feudals see little need to pay for them. In heavily feudal Punjab in recent years, the government has raked in some $40 million in agricultural taxes – but lost an estimated $1 billion to tax evasion. Unsurprisingly, Pakistan ranks among the worst in the world on development indicators such as child malnutrition and infant mortality. Pakistan’s literacy rate is 43 percent. Even Rwanda, torn apart by civil war, tops 60 percent.

What has filled the space left by the absence of the Pakistani state? Extremist Islam. Terror groups – perhaps even Bin Laden, the 9/11 Commission speculates – base themselves in the security vacuum of western Pakistan. Madrassahs, religious schools, have sprung up to fill a genuine void in the educational system – but some have indoctrinated Taliban and Al Qaeda members in an intolerant version of Islam.

In response, the 9/11 Commission recommends the US “make the difficult long-term commitment to the future of Pakistan.” That makes sense. Past US policies have been decidedly short-sighted. For instance, the US supported the military coup that ousted determined land reformer Khawaja Nazimuddin. (At the time, “land reform” sounded a bit too socialist for US tastes.) In retrospect, this was a grave mistake.

But the Commission’s recommendations – “military aid,” as “Musharaf’s government represents the best hope for stability” – overlook the true source of Pakistan’s troubles. Fundamentally, it’s the politics. What Pakistan needs is not a stronger military regime. (The inevitable result of a lot of military aid.) It needs development – particularly for the feudal areas, and the urban slums to which many peasants have fled. That will not happen without a different politics.

It is as Mumtaz Bhutto, scion of a great landlord family, once said: “This is a country of landlords. I come from a feudal family and make no apologies for that. Unless they can do away with agriculture and industrialize Pakistan completely, people here are stuck with me.”

[The extremely well-written 9/11 Commission Report is available from Amazon.com in hardback for about $20, paperback for about $7, or you can download it free and give your $7 to Kinko's. - Ed.]

To follow the plot in Vladimir Putin’s Russia, one needs to know the characters. In order of appearance –

The oligarchs. Russia is amply supplied with so-called “gangster capitalists.” But a few stand head and shoulders above the rest, with fortunes straddling natural resources, industry, banking and the media. A World Bank study – unraveling complex cross-shareholdings and shell companies – uncovered 23 of these “oligarchs,” who between them control an astonishing one-third of Russian industry (by sales) as well as seventeen percent of all banking assets in the country. The oligarchs’ wealth and control of media makes them politically influential. Indeed dominant, in Yeltsin’s day.

But they are also vulnerable. Most have broken laws of one kind or another – hard not to, given the chaotic environment of the 1990s. So they are vulnerable to legal attacks. And they are also politically vulnerable. The distribution of wealth in Russia is profoundly inequitable: according to Forbes, Moscow now has more billionaire residents than New York (33 against New York’s 31), yet the average Russian salary is $200 per month – a fact that inspires intense public anger. Not to mention that of the top seven oligarchs, six are Jewish, in a country that remains profoundly anti-Semitic. Two have been hounded into exile, and one, Mikhail Khodorkovsky, is in jail, and this is extremely popular. Some 54 percent of Russians say they are in favor of Khodorkovsky’s arrest, with only four percent strongly opposed. In the two weeks after he went to prison, poll ratings for the pro-government United Russia party rose by four points.

The siloviki. The term refers to former Soviet intelligence and military officials now at the top levels of the Russian civilian government. The rise of the siloviki – documented by Russian sociologist Olga Kryshtanovskaya – has been widely publicized by Putin’s political opponents hoping to cast his government in a sinister light. But the trend is both long-standing and, in a sense, natural. The siloviki – KGB and the military – were the Soviet elite; they are gradually becoming the Russian elite. In Gorbachev’s day, the siloviki made up only five percent of the Politburo. By 1993, under Yeltsin, their share of the National Security Council was 30 percent. By 1999, over 45 percent. And under Putin, nearly 60 percent.

But sinister or not, the siloviki’s rise changes things. The Russian state has been revitalized – more confident, more competent, at least at the highest levels. And also more dominant. The siloviki are thoroughly accustomed to government that is above the people, not of the people. At times, the wisps of Soviet nostalgia solidify into images some thirty years out of date. Washington Post columnist Anne Applebaum tells the story of a hydroelectric power project opening in 2003, complete with a band, speeches by Russian writers and the president, and cheering crowds. “We have managed not only to resuscitate and recreate everything that the energy sector of the Soviet Union and of Russia was proud of,” said Putin on the occasion, “but also to make steps forward.”

Small business. Small business has a role in the new Russia? No, and that is the point. The economy may have regained basic functioning but this is no broad-based revival. The plagues of corruption, predatory bureaucrats, and weak legal enforcement remain. Hence small and medium businesses account for only 10 to 15 percent of Russian output against 50 percent in the more advanced parts of Eastern Europe.

And this is unlikely to change. Small business gets little sympathy from the siloviki, who want to boost growth with state projects (like the Soviet-style dam). Nor from the oligarchs, who are actually helped by the poor business environment – smaller, less-well-connected competitors are hounded out of business, which keeps the oligarchs on top.

Oil. With small businesses relegated to walk-on roles, oil has taken the spotlight. According to the World Bank, oil and gas alone accounts for as much as a quarter of Russia’s GDP. Make no mistake, the more time passes the more Russia comes to resemble a petro-state. Natural resources now generate some 80 percent of Russia’s exports – nearly on par with Venezuela.

And with this come the trappings of the oil state – a government, enriched by oil revenues, that tends to dominate politics and the economy (as in Venezuela, Nigeria, Saudi Arabia, and so on). It is a slow process in Russia. Yukos and other oil companies were not paying their tax bills. (Taking advantage of legal loopholes, Yukos paid corporate income taxes of 20 percent last year, lower than the minimum of 24 percent.)

But it is a process reinforced by the key political players. The siloviki with their top-down instincts are happy to exert more economic control – and will, as they gain control of the oil sector. And Putin, who has now achieved direct or indirect state control of most major media outlets, is a natural when it comes to state-dominated politics.

Vladimir Putin. Which brings us to Putin himself. It is easy to imagine who Putin will see when he looks in the mirror a few years from now: a Saudi prince, or Nigerian general. Putin is not presiding over the “re-Sovietization” of Russia, as some have said – it is the “Saudification” of Russia. An economy where the state is the key player, and leading businesses stay that way through political favoritism. A politics where the people have little say in how they are governed. This is not a happy future. Putin’s Russia is dynamic, but oil states over time – thanks to their state dominance and corruption – tend to suffer economic sclerosis and political dysfunction. (Emerging in the form of Hugo Chavez in Venezuela and Islamic terror in Saudi Arabia.)

And yet. Forecasts of who Putin will see when he looks in the mirror a few years down the line have been wrong before. The players who were forecast to star in Putin’s Russia (oligarchs, regional governors) have instead been relegated to supporting roles. What if there were now a dramatic fall in oil prices? A major scandal? A presidential change of heart? The plot in Russia is still uncertain. Russia’s new direction may not be a promising one at present. But this is still a show worth watching.