Earlier this month Chinese revelers welcomed the new lunar year with a few more candles than usual. The country was gripped by a crisis in electric power production that caused California-style blackouts across the central and southern parts of the country. Power plants could not keep up with demand, especially because they didn't have enough coal on hand to burn.

The immediate causes of China's power crisis are straightforward. Snow storms disrupted the railroads that carry most coal to power plants. Record low temperatures also boosted demand for electricity and coal. But there was a deeper cause at work. China's free-market policies—the same ones that led to China's extraordinary growth in the past decade—have eroded the government's ability to control its economy. Economic activity, by design, is shifting away from state-owned enterprises and central planning. But Beijing doesn't have structures in place to control those aspects of the economy it doesn't own outright. Market reforms are making Beijing less and less relevant to what's really going on in the economy, threatening to turn China into a "weak state." And it's not just China—India, too, is having trouble regulating its industry and economy. The phenomenon is a dark cloud on the Asian century.

If this all sounds abstract, consider that China's blackouts were mainly a byproduct of the government's struggle to manage the planned and market-based parts of the economy side-by-side. Today, the Chinese leadership is worrying about inflation, but they have few useful tools to slow the rise in prices. A few years ago, Beijing might have dampened industrial growth by closing the spigot of finance from state-owned banks. But many newly deregulated state enterprises, as well as new privately owned companies, have found other sources of capital, including caches of massive profits accumulated over the years. One of the few industries Beijing still controls is power—it owns nearly every aspect of the grid, from generators to distributors. So Beijing decided to try and quell inflation by lowering electricity prices.

The energy industry, however, is bigger than just power generation and distribution. It includes the coal industry, which has been the object of market reforms. Starting two years ago the country largely abandoned the traditional planning system for allocating and pricing coal, the main fuel for power generators and one of the power companies' largest costs. Suppliers and buyers were allowed to negotiate on their own terms. With demand for electricity skyrocketing, suppliers had the upper hand, and coal prices rose. With Beijing keeping prices artificially low, power plants could not pass these costs to the consumer. They responded by cutting back on coal orders. As coal inventories dwindled, power generators cut back on capacity, and the lights went out.

Beijing's lack of practical control over large swaths of industry explains an increasing number of China's woes. The environment is a case in point. The government has an elaborate apparatus for environmental regulation, with strict laws on the books, but it is unwilling to enforce the measures for fear of stepping on the toes of local authorities, who usually push industrial development at the expense of greenery. Changing that power structure will require politically dangerous rewiring of the ruling Communist Party's power base. To be sure, Beijing is still powerful in some areas such as Internet regulation. And its recent success in imposing safety standards to close dangerous small coal mines, another area where Beijing is flexing its muscle, probably inadvertently contributed to the current coal crisis. Overall, however, what's most striking is Beijing's inability to impose needed regulation nor to predict what will happen when it does regulate. For example, a keystone in the government's effort to avoid future energy crises is an aggressive plan to improve energy efficiency about 4 percent per year over the current decade. The actual effect of Beijing's efficiency policies is barely one third that level.

These are not passing problems. They reveal a deep weakness in China's administration because the government has been unable to replace its Soviet-style planning system with an alternative scheme that is better suited to a market economy. Like an American film on the Wild West, much of the economy is governed by central strictures that don't really have much impact.

India is also plagued by administrative weakness—and the problems are getting worse as the Indian economy takes off and government struggles to address the byproducts of rapid economic growth. Large pockets of the Indian power grid are unreliable because Indian policymakers tinker with electricity prices in an effort to deliver political favors. (Electricity supplied to most Indian farms costs almost nothing and in some parts of the country is actually free. India has many farmers and they vote; politicians court them with stunts like free power. Poor accounting systems allow others who steal power to blame the farmers.) That tinkering has put most Indian power utilities into bankruptcy. The problems would be even worse if most of the power sector were not actually owned by the central and state governments in India, which shuffle money around to keep the companies afloat. Unable to get reliable power that is essential to industrial production, most large power users build their own power supplies. By some estimates, one third of the country's power plants are of this "captive" variety—by design, disconnected from the government-controlled grid so they are more reliable and also immune from political meddling.

The rise of weak states on the world stage will affect every aspect of international relations. It could send globalization astray. It will be hard to realize the full benefits of trade, for example, if essential countries are unable to enforce safety standards and trade laws. Fixing these problems may require a new style of international diplomacy that relies less heavily on deals such as treaties with central governments. Instead, specific contracts might be written directly with the segments of society that are best administered and most able to change their behavior. Taming the volcanic growth in Chinese emissions of greenhouse gases, for example, may depend less on whatever deal is crafted with Beijing and more on specific commitments that the West can work out with bosses in the Chinese power sector. How can China be a "responsible stakeholder" in the world economy if it can't actually follow through with commitments it makes in the international arena?

As the pundits gaze at the coming Asian century, they have wondered how Asia's new powers will reshape the world. But the big challenge in the coming Asian century may not be these new countries' burgeoning strength but their weakness.

"The Shape of Things to Come," a conference presented by the Stanford Program on Regions of Innovation and Entrepreneurship on January 17-18, 2008, featured keynotes by John Hagel, co-author of The Only Sustainable Edge and Co-Chairman of the Deloitte Center for Edge Innovation, and Dr. Henry Chesbrough, Executive Director of the Center for Open Innovation at the Haas School of Business at UC Berkeley and author of Open Innovation.

The keynotes bookended Thursday's forum, "New Patterns and Paradigms in Global Innovation Networks," and were a prelude to Friday's academic workshop, "A Global Perspective on Regional Innovation Indicators." Hagel's talk focused on the need for a more explicit taxonomy of innovative collaboration and discussed the "huge need to define pragmatic migration paths"--routes that the average manager and company can take to reach the opportunities that normally are only accessible to cutting-edge companies.

The forum closed with a presentation by Dr. Henry Chesbrough, who provided an overview on the globalization of innovation in the Chinese semiconductor industry, which he sees as split into a "globally oriented, globally competitive" industry segment and a domestically-oriented segment with "backward technologies" and lacking access to capital. The question, he explained, is how China will shift its resources, now entrenched in the latter, to the former, competitive segment.

Chesbrough finished with a discussion of intellectual property rights (IPR) in China, looking at flows of knowledge and current IPR challenges; he mentioned some surprising developments--the rise of businesses to "promote the legal exchange of IP" and the growth of a domestic constituency for stronger IPR--and discussed future implications for IPR in China.

In between the keynotes, the forum featured sessions on innovation in internet services in China, the role of venture capital as a network builder, and discussions on two rapidly moving industries: cleantech and thin film transistor LCD displays.

Conference materials, including presentations and audio files, will be made available on the SPRIE website.

Once the jewel in the crown of the formidable British Empire, India has been surrounded by myth for years. After gaining independence in 1948, this often misunderstood country found itself faced with a new sense of freedom -- and along with it, enormous burdens and challenges. While exotic, mysterious, and seductive, it has also become an economic force to be reckoned with. With the fourth largest economy in the world, the largest youth population on Earth, and a thriving middle class, India is the second-most-preferred destination for foreign investment. But very few Americans truly understand what a rich and powerful country it has become -- or its role as a global power, center of outsourcing, and potential partner with the United States.

From the country's thriving film industry to its burgeoning high-tech industry, as well as its attempts to stabilize its economy, India Arriving offers a fascinating glimpse into the real India, with all of its assets and all of its faults.

Author Rafiq Dossani goes beneath the veil surrounding India and considers the many ways it has begun to emerge onto the world stage. He explores its birth as an independent nation and forces like political shifts, social reform, and education that have helped to shape a new India. Honest and revelatory, India Arriving provides a deeper understanding of a country that promises to be the next major player in the world economy.

Pro: Not as Tempting

by Sabrina Siddiqui, intern, BusinessWeek, and a senior at the Medill School of Journalism at Northwestern University.

There is no doubt that over the last decade, India fortified its rule over the shared services and outsourcing (SSO) sector. Access to low-wage yet skilled workers allowed local global technology services giants Infosys (INFY), Tata Consultancy Services (TACSF), and Wipro (WIT) to employ tens of thousands of Indians to do work for such multinational corporate clients as Bank of America (BAC), Microsoft (MSFT), and Ericsson (ERIC).

But a recent study by Frost & Sullivan consolidates the idea that India's outsourcing has already peaked, and there are a number of factors to blame:

The Rupee Riddle. Earlier this year, the Indian rupee appreciated 8.4% against the U.S. dollar and touched 41.14 to the dollar, its highest rate in nine years. A significant reason for concern for the outsourcing sector, the upward value of the rupee continues to put a squeeze on earnings. By April, 2007, it had cut margins by about 2.5 percentage points.

Cost (In)Efficiency. Companies looking to outsource have long seen India as their most cost-efficient vehicle. But with wage inflation running 15% to 25% per year, India can no longer use the siren song of its labor being the cheapest. Competitors like China can offer their services at a lower cost, while firms like Infosys are stuck recruiting from outside the country, because the comparable Indian staff is growing too expensive.

That Age-Old Infrastructure. As much as the economy continues to boom, how long can it sustain its position when IT operations spend considerably on backup systems to fight regular blackouts? And the 300,000 engineering students who graduate each year may be short of the level needed to support modernization of infrastructure and industry growth. (Not to mention that the peculiarly accented "Doug Smith" on the computer help desk is a little too hard for U.S. callers to comprehend.)

So if you assume you're being rerouted by tech support to a call center in Bangalore, guess again. It seems India's grasp on the SSO market is at long-term risk, and it just so happens that your call might be answered by someone in Shanghai.

Con: Plenty of Spice Left

by Rafiq Dossani, Stanford University and Martin Kenney, University of California, Davis

Notwithstanding the occasional news stories about companies returning work earlier offshored to India, the logic behind offshoring and its financial impact (both on outsourcing firms operating in India and their American clients) remains intact. First, the logic: A fresh engineer costs $8,000, including benefits, on average in Bangalore. Even a "Google-quality", presumably equivalent to the best Google can hire anywhere (in fact, Google offers its India recruits the option of working in Silicon Valley if they so desire) costs $30,000. These wages are much lower than in the U.S. and will remain that way for at least a decadeespecially if the ambitious graduation targets of Indian education policymakers are realized.

Of course, there are problems in doing work long distance: Coordinating the work of global teams is costlier than coordinating such work locally. The intellectual property issues could be important. But offshoring is now tried and tested enough, and large corporations are deeply committed to it.

By 2010, many large multinational corporations like IBM (IBM) will have their largest workforces in India. This is creating a relatively rich ecosystem in a number of Indian cities, especially Bangalore.

Already, for a number of these firms, their Indian operations are being declared global centers of excellence, whose value goes well beyond just cost savings. Undoubtedly, some smaller firms have faced high initial costs, but even they, particularly the technology firms of Silicon Valley, have committed to Indian operations. Firms such as Infinera (INFNO) and HelloSoft have substantial Indian operations that are critical to their success. For them to retreat would require a major reorientation of their business strategy.

The appreciating rupee will, like rising wages, affect offshoring decisions. However, the Indian system integrators such as TCS, Infosys, and Wipro, which are also being squeezed by costs, have experienced profits rising at about 35% a year for the past decade and enjoy margins in excess of 20%. This provides ample room to absorb rising costs.

There can be little doubt that the Indian ecosystem is maturing. However, the growth of offshoring to India has not peaked.

Reprinted by permission from BusinessWeek.