Does crony capitalism promote economic growth? Ensure that your answer demonstrates a sound understanding of the literature and is illustrated by specific examples drawn from today’s political and economic situation of any country or countries of your choice.
This paper discusses Crony Capitalism (cronyism) and illustrates many outcomes from this form of economic governance. It compares the efficiencies and inefficiencies of cronyism, implies a difference between corruption and cronyism, and that cultural heritage influences economic practice.
Economic growth is seen as a long-term increasing capacity of a nation-state to supply increasingly diverse economic goods to its population. This is based on advanced technology and the advancement of institutional and ideological organisations (Kuznets, 1973). It is influenced by increases in productivity through technology and innovation, economies of scale, and growing populations (Ayres, 1998 and Ayres & Warr, date unknown).
Cronyism in its lightest form can be described as collusion between key market players, but can also describe the cosy, symbiotic relationships between big business and the state in Southeast Asia (White, 2004). Kang (2003) refers to successful cronyism as ‘grudging relationships’ between government and business elites, creating mutually hostage situations. It materialises through favouritism toward business groups with respect to legal permits, government grants, tax breaks, and access to capital loans. Morck et al (2011) describe it as “elite-capture”, where “business-families” attain sufficient control over an economy’s financial sector.
The neoclassical argument states any government intervention removes the market from equilibrium resulting in a less efficient economy. However, in instances where mutually hostage parties occur, cronyism can reduce transaction costs and minimise deadweight losses (Kang, 2003) therefore increasing productivity. South Korea is a high performance economy, and has only a few key actors (the state and Chaebol) in mutually hostage situations. The result is stability, as neither one side nor the other can dominate. Granovetter (1985) further argues that more stable personal relationships between economic actors and the ensuing trust, is more important in discouraging opportunism than formal institutions. Immutable stable laws and trading environments can lead to durable agreements that are a prerequisite of economic growth, and Kang (2003) infers it is more agreeable for foreign investment.
In contrast both the Philippines and Indonesia have not provided economic growth through cronyism. In the Philippines too many actors result in a lack of cohesion, increasing transaction costs and decreasing its economic performance. Kang (2003) refers to this as a “pendulum of corruption” between business and state. In the case of Indonesia, cronyism was centred on Suharto. Initially stable, Suharto’s regime experienced sustained and impressive growth and foreign investment surged into Indonesia. However, Suharto’s stifling self-interested regime controlled almost 60% equity in all domestic investment by 1980 (Kang, 2003). The business sector was never able to become independently powerful outside of Suharto, hence no mutual hostages, resulting in high levels of corruption and increased transaction costs.
Figure 1: This graph shows the levels of high technology exports plotted against time of Indonesia, Philippines and South Korea. Data was taken from data.worldbank.org.
Figure 1 illustrates varying levels of technological export of 3 crony-economies, and that different versions of cronyism can result in different levels of technological advancement. The less corrupt the form of cronyism, the higher the level of technological advancement, which is a key indicator of economic growth (Kuznets, 1973).
Hill (1995) pontificates that the key to minimising the resource costs is maximising the productivity of resource inputs, requiring both cooperation and investments in specialisation. Hill argues that if a government gets it ‘approximately’ right then confidence among economic players regarding property rights and contracts reduces transaction costs thereby increasing economic growth and specialisation. He further discusses how the cultural norms within a society can act as a large behavioural constraint and will determine how individuals interact in everyday situations.
Figure 2: This figure shows GDP per capita in US$ plotted against time of Japan, United Kingdom, South Korea, Indonesia and the Philippines. Data was taken from data.worldbank.org.
Figure 2 shows the relationship between GDP per capita (which can be taken as a factor of productivity) of various countries. Japan’s surge in productivity from 1975-1995 perhaps indicates how ‘Japan Inc’ got it ‘approximately right’ through this period with larger gains than the UK. However, this graph implies that cronyism was not effective for the Philippines and Indonesia from 1970 to present day.
In Japan MITI served as an architect for industrial policy, and coordinated efforts with the Bank of Japan and other agencies to promote economic growth. The central government facilitated and spearheaded Japan’s economic expansion and brought about a radical transformation of industrialisation (Johnson, 1982). MITI relied upon personal relationship building over expensive formal institutions, and would exclude transgressors from informal associations between government and business leaders (Murakami and Rohlen, 1992). Hill (1995) hypothesises that the economic growth seen by Japan until 1990 was not only due to cronyism but also to the societal factors prevalent in Japan at the time, based upon the Tokugawa Value System of cooperation. This collective ideal resulted in a competitive advantage of Japanese firms over Western firms and reduced transaction costs and risks of hold up, therefore promoting investment in specialisation. Japan should not be mistaken for a command economy but perhaps a ‘developmental government’ as coined by Johnson (1982).
Figure 3: This figure plots the GDP growth (annual %) of various countries; Japan, United Kingdom, United States, Indonesia, South Korea and the Philippines. Data was taken from data.worldbank.org.
Figure 3 highlights differences in annual % growth rates of GDP, and shows crony-economies have higher growth rates than typically ‘laissez-faire’ countries such as the UK and USA. It is worth noting that the more developed Japan has a lower growth rate than other crony-economies, perhaps indicating cronyism does not promote economic growth in today’s global markets. In contrast Keegan (1984) argues that ‘Japan Inc.’ actually increased its competiveness in global markets through joint public and private goals.
Morck et al, (2011) talks of “big push” industrialisation and implies that large family controlled businesses use “tunnelling” to coordinate investment as a central planner might. However he goes onto to assert that ‘elite-capture’ correlates with less efficient capital allocation, and economies with large family-banks are prone to ‘boom and bust’. He presents empirical evidence showing family controlled banking systems decrease both real per capita GDP growth and TFP growth.
Kang (2004) argues that cronyism develops in economies where legal and political institutions are not developed, and transaction costs of regulating contracts are excessive. In this instance it is cheaper to revert to cronyism.
In conclusion minimising transaction costs is a key component to economic growth and that in the right circumstances cronyism can offer this, as seen in Japan and South Korea. Corruption is more prevalent in regions with less established legal frameworks and cronyism fails to deliver sustained economic growth. Cronyism is also closely linked with family-banking systems, which result in inequality and increased barriers to entry thus decreasing the competitive nature of the economy. My interpretation of the data is that crony capitalism can, in circumstances promote economic growth, where collaborative ideals are upheld such as in Japan, and when few economic players exist, but that growth is not long-term. I also conclude that once economies move into today’s global markets and must become internationally competitive cronyism does not promote economic growth.
GDP – Growth Domestic Product
MITI – The Ministry of International Trade and Industry
TFP – Total Factor Productivity
Ayres, R.U. (1998) Turning Point: an End to the Growth Paradigm. London: Earthscan Publications [online]., pp. 192-195.
Ayres, R.U. and Warr, B. (?) Two Paradigms of Production and Growth. [online]. Source incomplete.
Granovetter, M. (1985) Economic Action and Social Structure: The Problem of Embeddedness. The American Journal of Sociology [online]. 91, pp. 481-510.
Hill, C.W.L. (1995) National Structures, Transaction Cost Economising and Competitive Advantage: The Case of Japan. Organization Science [online]. 6 (1)
Johnson, C. (1982) MITI and the Japanese Miracle: The Growth of Industrial Policy. Stanford, Ca: Stanford University Press.
Kang, D. (2003) Transaction Costs and Crony Capitalism in East Asia. Ph.d. Comparative Politics [online]. 35 (4), pp. 439-458.
Kuznets, S. (1973) Modern Economic Growth: Findings and Reflections. The American Economic Review [online]. 63 (3), pp. 247-258.
Murakami, Y. and Rohlen, T.P. (1992) Social Exchange Aspects of the Japanese Political Economy: Culture, Efficiency, and Change. The Political Economy of Japan. Cultural and Social Dynamics, Stanford University Press [online].
Morck, R., Yavuz, D. and Yeung, B. (2011) Banking system control, capital allocation, and economy performance. Journal of Financial Economics 100[online]., pp. 264-283.
White, N.J. (2004) The Beginnings of Crony Capitalism: Business, Politics and Economic Development in Malaysia, c 1955-70. Cambridge University Press, Modern Asian Studies [online]. 38 (2), pp. 389-417.
Well, i am not 100% sure this is the fight of the century, perhaps more the fight of all centuries. Another great take on the continuing battle between liberal Hayek economic theory and the Government intervention promoted by John Maynard Keynes.
This video has been put together by EconTalk‘s Russ Roberts and John Papola, and i strongly advise you get involved in the fantastic set of podcasts from Econtalk. check the website here http://www.econstories.tv.
Having balanced on the edge of the edge of a depression after the financial slump seen in 2008, there are still many questions being asked by economists and policy makers so as to speed up the recovery in many capitalist nations, as growth and employment are slow to recover than anticipated. Should we push for more fiscal stimulus, should spending be steered and from the top down or does prosperity come as green shoots from the bottom up?
Listen to this great rap video, to get a take on all these and more.
Discounting is an interesting concept when it comes to Business Economics. This concept is concerned with future costs and benefits arising in future years being worth less to us than should we achieve those same costs and benefits today. This is important in not only the accounting department, but to decide the cost implications of certain management decisions, or whether to invest in something or simply leave it in the bank on a fixed interest rate.
Time preference = money today is better than money tomorrow.
Therefore, all future costs and benefits must be discounted at an appropriate rate of interest. This is referred to as the Discount Rate.
Net Present Value = SIGMA ((St/(1+r) to the power of t)
SIGMA = summation
S = future sum
r = discount rate
t = number of years to elapse before the sum received
Seeing as this concept is a bit awkward to get your head around, lets try a simple example.
A landowner is going to receive a rental income of £5,000 over a 4 year contract. Lets us assume the bank would offer a generous interest rate of 10%. This would therefore make the discount rate 10%. Let us work out the total income for the landlord.
NPV = SIGMA ((st)/(1+r) to the power of t)
NPV = (5000/(1+0.1)) + (5000/(1+0.1)(1+0.1)) + (5000/(1+0.1)(1+0.1)(1+0.1)) + (5000/(1+0.1)(1+0.1)(1+0.1)(1+0.1))
Therefore the contractual sum of income can be seen to decrease in real terms over the period, and this is important when factoring capital investments.
Japan has had a long and protracted economic crawl over the last 15 years. It has not really followed any norms of current taught economic theory. In economics there are certain rules we look to embrace, otherwise we have little founding on which to base arguments and theories. One such rule is that all business managers aim to maximise profit, but Richard Koo has a theory (based on acute observations made over the last 15 years in Japan) that these rules of engagement are being broken in this current economic climate.
Normal recessions will be brought about due to an overproduction of something, the tightening of monetary policy or inflationary pressure. But in this instance this is not the case. He suggests that this is a not a normal recession, but instead a new disease. He calls it a Balance Sheet recession. This is when business managers are looking to minimise debt instead of maximising profits.
Normally when interest rates are low, business managers will look to borrow money so that they can invest and grow sales. However Richard Koo suggests that although the current interest rates are low business managers are not looking to borrow more money, but are instead paying down debt.
He argues there are two forms of bankruptcy. You can be bankrupt without cashflow or with cashflow. If you have no cashflow and your balance sheet is ‘underwater’ you go out of business. Simple… However, if you are bankrupt with cashflow, the best for all stakeholders in the company, from shareholders to workers, is to use this cashflow to pay down debt. The idea being that if you can reduce this debt over a few years, then the company can work its way out of this liquidity issue and re-emerge to trade normally once more. This is the right thing to do at a micro level, but Richard Koo asks us to look at the macro level.
In the ‘assumed economy’, bank deposits are used by the financial sector to loan to other business to generate further sales and profits. However, if your balance sheets are in jepordy then business will not look to take on further loans but instead pay down debt. If all business are looking to pay down debt, and thus are not borrowing nor spending then affects are protracted. He equates this current economic dilema to the Great Depression, and says that this is what has been happening in Japan for 15 years.
He believes that only the opposite of public saving and debt reduction from the government can actually solve this issue. Government borrowing and spending, as in China in 2007, is the only remedy to this ‘pneumonia’.
Are we seeing a returning argument for the role of mixed market economies, and Keynesian Economic Theory?
Some interesting ideas to take into my first economics lectures next year. I swear this is one of the best/worst times to be learning about economics!!!
Here is a quick 20 minute interview with Gerald Celente from the Tommy Schnurmacher Show, on the 09.11.11. We are all aware that Gerald Celente has been scarily correct with many of his predictions on economic and social events, such as the 2008 financial crash, the London Riots, the Gold Bull Run and even the Occupy Wall Street Movement. Some say he is a living Nostradamus, but that could be a little sensationalist. He does however, paint an interesting picture, and has some scary predictions and I believe his viewpoint is definitely worth hearing. Founder of the Trend Research Institute and Direct Democracy Now he is a big advocate in shifting the current economic and political systems, to spread the wealth and power around to all constituents, rather than just a few.
In this interview, he states that the world economy is more connected than we could ever imagine, and that the engine we believed was going to pull the world from this current Financial Crisis, China, is not working. If the West does not consume, the Chinese does not manufacture and that Chile and Brazil will follow suite as a supplier of natural resources. Mr Celente suggests until we have hit rock bottom we do not act, and that this is Global Destabilisation.
In this he also talks of a ‘New World Order’ that has been passed around as a Conspiracy Theory for years, but begins to argue that this is happening now. As the US Federal Reserve lends Trillions of US $’s to Banks, which lend to Governments that default on loan payments, the power shift toward the economic elite is enormous. This could be classed as a land grab, for all the natural resources, electric supply, land and farming by those in control. He argues that bailouts are not bailouts, but instead control through debt. The more indebted a country, the higher the taxes, the more the people work to pay the loan interest owed to a few.
Its all pretty scary stuff, but i think that this is important to hear, so that we can aim to develop and implement a plan to avert this pending shift. Although my question is, seeing as the Global Economy is so very complicated that not only can we not fully understand it, what actions can actually be taken to make change?
There are two competing primary kinds of economic system in this world, Command Economies and Market Economies.
Command Economies function with a form of economics that is directed by a centralised government. Rules and regulations are imposed by this government to regulate the way in which goods and services are supplied.
Market Economics, are driven by just that.. the markets and Private Enterprise. There is little or no restriction imposed from any centralised governance, and the businesses are left to their own devices. The reasoning behind this system is that if the market wants a product it will be seen as a demand and thus supplied. Historically this form of economics has offered far more sustainable economic growth, and far more individual and business freedoms. This Private Enterprise System is effectively based on Capitalism and Competition.
In addition to this Private Enterprise system, there are also planned Economies where a centralised body decides on business ownership, profits and resource allocation. This is a version of Command Economics. One of the most famous forms of this economical policy is Communism which states that all property and business is owned equally by all (ie the State), and that a strong central government dictates what goods are supplied at what level and price.
In Marxist theory, “communism” denotes the final stage of human historical development in which the people rule both politically and economically.
There is another economic system called Socialism. Socialism is an economic system characterised by predominantly privately owned businesses, and the State owns and controls what is believed to be the most important industries for the nations needs such as fuel and telecommunications. The Governments are also responsible for a variety of ‘national need services’, such as transportation, waste removal, unemployment benefits, free national healthcare. In order to sustain these large state expenses, large income taxes are applied. This results in a particularly non-dynamic economy, as entrepreneurs are not incentivised to start businesses due to large parts of their profits being removed through Government taxes. Socialism is a combination of both Capitalism and Communism.
Many of todays economies are actually a mixture of both planned and market economies, and these are referred to as Mixed-Market Economies. Followers of Milton Friedman, will not agree with this form of economics, as they are true advocates of the Free Market theory and that markets will ultimately balance themselves out and offer the best and most fair situation for all.
In the UK, USA and around the world the Free Market System was introduced throughout the 1980’s and beyond. Gordon Brown introduced his ‘light touch policies’ throughout London’s Financial Sector as both London and New York competed for the top spot for The Global Financial Capital. However, as has been proven, this light handed fiscal policy and the de-regulation of the Banking Sector resulted in the worst financial collapse in human history.
Although, one has to ask the question as to whether it was the free market system that failed, or the ethics of those taking the risks. Perhaps with a higher moral path, this free trade system would work and the markets would be able to balance and regulate themselves. However, for this new moral code to take effect the human species would have to undertake a huge social change immediately and perhaps have some form of ethical awakening. Realistically, this is not going to happen as this form of social change takes many years to implement and take root. What we require is leaders within the business and political realms to act with a higher level of ethics, and to take responsibility for their actions. I believe that theoretically the free market system might actually be the best and most efficient system for economic development and growth, but i feel that looking purely at a rising GDP should not be the only bench mark. We need to look for and strive to attain a lower level of inequality and higher standards of living. We live in a world that is not a perfect petri-dish to test economic policies and so some initial regulation is required of key sectors so that ‘Joe Blogs’ does not suffer in a quest for a rising bottom line in a resource restricted world.