Asian Business Environments BSP2005 Week 10

Lecturer

Peter Zeitz

Why do many states with inclusive political institutions fail to adopt good economic institutions?
Weak vs. Strong States
State strength is similar to a technology.
A Strong state tends to persist over time.

Weak states do not become strong easily.

Many democracies are relatively weak states.

Common characteristic of weak democracies
Ethnic/Religious Diversity
e.g. African states combined historically antagonistic ethnic groups

Weak states are associated with extremely bad growth outcomes.

Many examples of strong extractive states that have been exceptionally prosperous. Not so for weak states.

Political Risk
Theory says that democracies should have more stable growth patterns. Growth in non-democracies should be more unstable.

Who Benefits from Economic Growth?

Profit 25%

GDP
Tax 20%

GDP is divided among labor and capital owners

Median voter is a worker. Inclusive growth implies policies that maximize labor income.
Wages set by collective bargaining Minimum wage Strong Antitrust Enforcement
Wage Comp ensati on 55%

Who Benefits from Economic Growth?

Profit 25%

GDP
Tax 20%

GDP is divided among labor and capital owners

Median voter is a worker. Inclusive growth implies policies that maximize labor income.
Wages set by collective bargaining Minimum wage Strong Antitrust Enforcement
Wage Comp ensati on 55%

Elites earn most capital income. Extractive growth implies policies that maximize capital income.
No collective bargaining No minimum wage No Antitrust enforcement
Recall the Carlos Slim, worlds wealthiest individual
Profit 40%

GDP
Tax 20%

Wage Comp ensati on 40%

Division of labor and capital income in democracies and nondemocracies

Democrati c Transition s in East Asia

Current institutions are enduring consequences of past historical events.

Inclusive institutions first developed in United Kingdom
Persistently strong institutions in Western Europe

European colonizers spread different types of institutions around the world.

Hmm country has dense population, natural resources, and centralized indigenous government
Extractive institutions are already there. Just need to replace the indigenous leaders. Many countries in Central and South America -> Extractive Economic Institutions, Comparatively Strong State Utilize as source of slaves -> Extractive Economic Institutions, Weak State Most of Sub-Saharan Africa

Hmm country has relatively dense population relative to fertility, lacks indigenous government Hmm country has sparse population and lacks natural resources

Settle there, use inclusive economic institutions, eventually inclusive political institutions United States, Canada, Singapore, Hong Kong -> Inclusive Economic Institutions, Strong State These settler economies have done very well in the long-run.

What if Singapore was located in Africa? Illustrative Example: Mauritius

Extremely isolated African Island-state Uninhabited until 1710 Population is a mix of African, Indian, French and Chinese immigrants Lacks natural resources

Strong democracy

Major African financial center; export-focused industry

GDP per capita (nominal and PPP) similar to Malaysia 19 times higher than neighboring Madagascar

Some evidence that extractive elites are Hard to Get rid of

Mita: Legally Designated Slave gathering Area in Inca empire Map shows Mita boundaries in Peru and Bolivia

Institutions and Firm Operations: An Example

Why this is surprising?

No obvious characteristics of workers or machines explain this difference. US workers are typically migrants who may not speak English and may never have been to school. They begin working several times more efficiently than Asian workers with no experience whatsoever. Workers in US and China, Japan, and India often use the exact same model of imported British machine. Even in Asia, managers and engineers are often British.

Management and Institutions

In Britain and China firms are organized under a subcontracting system.
Highly decentralized Forepersons hire, pay, and supervise machine operatives. Management paid forepersons based on performance. Very similar to practice in Britain; effective in Britain

Chinese Labor Institutions Different from British.

Bribery, organized crime plays a central role in the hiring process.

Agency Problem: Bribery makes subcontracting less effective in China than in Britain.

Chinese Labor Institutions

Patron-client relationships mediate hiring.

Workers pay foreperson annual fees for jobs (two weeks wages).
Forepersons belong to criminal organization, Green Gang. Gang brokers sale of labor.
Controls recruitment of rural labor (fee-based or indentures). Gang networks important in urban job search. Instigates strikes and riots to coerce firms.

Forepersons as a Barrier to Productivity

Chinese forepersons are quite powerful compared to managers. *Forepersons+ do not do much work nor know much and usually do
not stay in the mills all the time. Most Chinese managers are afraid of them and would not dare do or say anything against their will. (Lee 1925) Forepersons maintain power by inciting workers to strike, riot, or quit.

Forepersons profit from job placements. Gang earns additional profits through control of recruitment. Blacklists discourage workers from seeking jobs directly. Collective action is used to force excessive hiring. "the principal trouble [in management labor relations] is that a
mill is practically forced to employ more people than is necessary and wages are only of secondary importance. (Barker 1934)

Institutions around the World

What are the best institutions for economic growth?
Is there a single set of institutions that is optimal for every nation in the world at every point in time? Is it important that a country adopt a single set of institutions or are there multiple institutional paths to development?

Perspectives in Acemoglu and Robinson are very Eurocentric and focused on 19th and 20th century history. Perhaps inclusive democracies are not the only/best way of sustaining growth.
Is it adequate to characterize countries as either democracies or nondemocracies?
A considerable diversity of institutions exists within each group.

Xus China Puzzle

China has never been a true colony. By best practice based measurements, Chinese institutions are worse than average for developing economies.
Quality of government, rule of law, corporate governance

The coexistence of bad institutions and great growth China Puzzle Use of Western standards to measure institutions ignores important Chinese institutions that deal with incentive problems. Institutions are related to Chinas long imperial history.

Emperor

Central Adm Function

Territorial Control

Personnel

Finance

Justice

Industry

Province A Province B Province C

Personnel

Finance

Justice

Industry

Central Gov't

Central Adm Function

Territorial Control

Personnel

Finance

Agriculture

Industry

Province A Province B Province C

Personnel

Finance

Agriculture

Industry

Regionally Decentralized Authoritarianism (RDA)

China is one of the most politically centralized countries in the world.
Provincial level officials appointed by central govt. Provincial level officials appoint lower-level officials. Personnel control is an incentive instrument.

Highly decentralized economy - subnational governments control policies and resources.

Fiscal Decentralization (provinces do the vast majority of govt spending) Firms fall under influence of local governments.

The RDA determines Chinas policies, development and problems.

Centralized Political Governance

The central government
controls personnel matters of subnational governments. delegates and rescinds powers to regions.

Centralized personnel control deals with incentive problems.

Appointment, promotion, demotion, and cross-region rotation of regional leaders are control instruments. Rewards, penalties, and regular performance assessment are control instruments.

Regional Experiment Key to Institutional Change

Economic reforms are risky and controversial (contrary to ideology and harmful to vested interests).
Regional decentralization allows for low risk experimentation.
Reform can fail without bringing down the country.

Regional competition encourages some provinces to invent new institutional arrangements to promote economic growth.
Land Reform, Special Economic Zones, Privatization, New Forms of Enterprises

What about the evidence? How does a Chinese provincial leader get promoted?
1) By knowing the right people 2) By submitting tax revenue to the Central Govt (achieving GDP growth doesnt matter in practice)

3) By having strong educational credentials